Wall Street Analyst: IBM is hedging its bets on Ethernet switches

We're noting increased incentives for the IBM sales-force to resell its "own" gear rather than "competing" brands.

I want to share with you a research note that I received today from RBC Capital Markets Managing Director - Mark Sue, "IBM is hedging its bets on Ethernet switches and has announced deals with Brocade, Cisco and Juniper. The Brocade and Juniper switches will be branded IBM and we're noting increased incentives for the IBM sales-force to resell its 'own' gear rather than 'competing' brands. Brocade may have the jump start with its family of NetIron and FastIron re-branded as the IBM C, G, M and S-series as Juniper's products are not expected till late 2009. Near term segment strength for Brocade may come from global services and Ethernet and we did note healthy demand for DCX line as well.

"Brocade is set to report solid results Thursday evening driven by strength in North America (~70%); RBC is estimating revenues closer to our $507M (flat sequentially) vs. Consensus of $503M. EPS based on gross margin improvements and opex control may come in a penny better than the street's $0.11. Growth in fiber channel switches and an improving fed pipeline are some positives heading into the fall."

Sue continued, "Ethernet OEM partner IBM may be moving a bit slower than some aggressive views and Brocade may reiterate and not raise its full year guidance, implying that the consensus revenues for October at $547M (+8% QoQ) may remain broadly unchanged post results. We do however expect the consensus CY10 EPS of $0.68 to move modestly higher due to improved margin visibility. Brocade's stock trades at just 12X CY10 EPS."

Sue added, "Gross margins may improve from 56.2% as Brocade unwinds the impact from the purchase accounting adjustments for Foundry. Brocade may further point to strong progress in the supply chain and product cost synergies; we expect Brocade to reiterate its LT range of 58%-61%. Foundry had margins in the low to mid 60s so 61% may be reasonable even as the OEM business ramps."

Sue concluded, "Balance sheet metrics are improving for Brocade; expect healthy cash generation of ~$50M this quarter and ~100M in seasonally strong 4Q09. We're not sure a convertible debt is in the works as Brocade looks for better terms on its $940M debt yet our analysis of debt deals to date do not signal significant stock price degradation following the announcement (see table below):"

Source: RBC Capital Markets

Do you agree with Mark Sue that IBM is hedging its bets on Ethernet switches?

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