RBC Is Bullish On Brocade Following Possible Sale News

RBC Capital upgraded Brocade Communications Systems, Inc. BRCD to Outperform from Sector Perform after Bloomberg reported that the company is in advanced talks to sell itself to Broadcom Ltd AVGO.

“We think that Brocade makes sense as a strategic asset to the right operator or CEO (Hock Tan as a solid operator), which would lead to mid-single-digit accretion for the acquirer (35%+ operating margin potential),” analyst Mitch Steves wrote in a note.

Steves said the potential acquisition would be $0.65 accretive to Broadcom if it manages to snap Brocade for $15 a share and achieve $200 million in opex synergies. The assumed $15 purchase price represents a premium of 73 percent over Friday’s close of $8.69, before the M&A speculation.

Brocade has about 70 percent share in the Storage Area Network (SAN) market. At the end of May, Brocade acquired Ruckus Wireless, which helps the company gain share within the IP networking segment. Steves expects the company to generate more than $1.10 in EPS in fiscal 2017.

Steves noted that other potential suitors could include large IT Hardware/Networking companies such as International Business Machines Corp. IBM/Hitachi, Ltd. (ADR) HTHIY/Oracle Corporation ORCL. The analyst said Broadcom has an edge given “larger margin for payment and the transaction would not overlap materially with its customer base.”

The analyst raised his price target by $3 to $14. Brocade has traded at about 11x earnings over the last 10 years.

“With potential for $1.10+ in FY17E EPS, we think a multiple of 10x is below the strategic value of the company,” Steves added.

Shares of Brocade surged 22 percent on Monday to close at $10.60, while Broadcom closed at $170.28.