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Product overlap clouds McData/CNT deal

McData's $235 million purchase of CNT raises a red flag for users due to product overlap between the two companies.

McData Corp.'s surprise acquisition of Computer Network Technologies (CNT) is ringing alarm bells in certain sections of the user community this week as overlap between the two companies' product lines means that something has to go.

United Airlines' senior systems architect Gary Pilafas runs a Brocade shop but was ready to "sweep the floor" and replace this gear with CNT's UltraNet Multi-service Director (UMD). He said he's putting his purchase on hold to see if the product survives. "It freezes everyone's wallets … This deal is like McDonald's buying Burger King -- there's so much overlap," he said.

It freezes everyone's wallets … This deal is like McDonald's buying Burger King -- there's so much overlap.
Gary Pilafas
Senior systems architectUnited Airlines

Strangely, just as McData announced it would buy CNT, it also unveiled its new Intrepid i10K director switch, which competes head-to-head with CNT's UMD. Long term, most analysts think it's unlikely that both products will survive. "They are so close in features and functionality that there is no reason to have both," said Nancy Hurley, senior analyst with Enterprise Strategy Group.

Other products that overlap include CNT's UltraNet Edge Storage Router and McData's family of Eclipse SAN routers, which it picked up with the acquisition of Nishan Systems Inc. These provide Fibre Channel disk mirroring and SAN connectivity over IP, ATM, or SONET networks. "Why would anyone buy these products knowing that in six months to a year's time they might be cut," said Steven Berg, analyst with Punk, Ziegel & Co., in a note to investors.

To sort out this problem, McData has set up an integration office with the task of planning for a combined product and services road map. "It would be premature to speak about that today," said John Kelley, chairman and CEO of McData, during a call with press and analysts. "But we are optimistic that we will be able to reconcile these issues by taking the best from each company."

Professional services

On a positive note, McData gets a professional services business it didn't have, a large customer base in Europe and some lucrative SAN extension products for remote data replication. The services part is important to McData as it attempts to extricate itself from its stifling OEM partners.

"CNT sells directly to users, which is a way for McData to diversify away from EMC and IBM," Berg said. Then there's CNT's SAN extension products, including all its traditional mainframe connectivity products and more recently the UltraNet Replication Appliance, which provides heterogeneous long-distance replication for disaster recovery and business continuance.

Yankee Group senior analyst Stephanie Balaouras said she believes that over the next 12 months, backup and recovery, data consolidation and disaster recovery are key priorities for many IT shops. In fact, she thinks McData might be wise to hop on the WAN trend for centralizing backup and put the intelligent switch gear on the backburner. "There is definitely more interest in these applications than putting intelligence in the fabric," she said.

CNT, for its part, bags a stable parent, which should come as a relief to the company's management. According to Yankee's third-quarter 2004 market share numbers, CNT had 9.1% of the director-class switching market, McData had 38%, and Cisco Systems Inc. and Brocade Communications Systems Inc. had roughly 25% apiece. Balaouras noted that the combined company is now "well ahead" of Cisco and Brocade in this sector.

"CNT was the fourth player in an overcrowded market," said Hamish MacArthur, founder of analyst firm MacArthur Stroud International. He thinks the deal is good for CNT users as it provides "a soft landing" for them, rather than "if they were just left with a company that might eventually face Chapter 11".

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Financial details

The all stock deal is valued at approximately $235 million in equity and debt. CNT shareholders will receive 1.3 shares of McData Class A common stock for each share of CNT common stock they hold. Upon completion of the transaction, which is expected in McData's fiscal second quarter 2005, McData and CNT stockholders will own approximately 76% and 24%, respectively, of the combined company.

McData will assume approximately $66 million in net debt at the close of the deal and plans to issue 40 million shares to finance the transaction. Headcount reductions are expected.

McData did not give details on targets or timetables, but expects the acquisition to yield an annual operating income improvement of $25 to $35 million. It also expects the deal to be accretive to fiscal 2005 earnings per share. There is a breakup fee of $1 million associated with the transaction.

Market consolidation

Keeping track of what company is acquiring what is almost a full-time job in the storage market right now. EMC was constantly in the headlines during 2003 buying companies. Then Symantec pulled a blinder with the acquisition of Veritas Software Inc. at the close of 2004. The switch players have been on a consolidation bent for a while. CNT acquired InRange Technologies Corp. for $190 million in April 2003, consolidating two director-class switch providers, and InRange itself is a collection of different companies. It's anyone's guess what company will be next. In the meantime, the companies that best help users through these integration headaches and product transitions will be the ones that survive.

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