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Will Brocade investments pay off for users?

Brocade's splurge on Tacit and Therion this week is a Band-Aid hiding much deeper wounds.

Brocade this week announced a $7.5 million investment in wide-area file services (WAFS) company Tacit Networks Inc. and a day later it picked up Therion Software Corp. for $9.3 million, an unknown company in the storage management space. How this will help Brocade Communications Systems Inc. customers remains to be seen. The firm has only recently begun to roll out the results of its acquisition in 2002 of Rhapsody and intelligent switches have yet to make an impact.

Users have a right to be skeptical that these recent moves will move Brocade into the front ranks of innovation. Cisco Systems Inc. made its move into WAFS six months ago with the acquisition of Actona Technologies Inc. and for what it's worth, passed over Tacit.

As for Therion, Brocade isn't even telling anybody what this company does, although it has been working with the firm for over a year. Brocade wasn't expecting to announce the Therion deal or new technology based on this product until June 1, at its annual conference. Analysts have speculated that Brocade made the announcement shortly after preannouncing its earnings shortfall to try and boost its stock price. It didn't work.

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Stunts like this are not likely to help Brocade recover its credibility in the market. And minor investments in emerging technology companies are not enough to lead a marketplace it once totally dominated.

And boy, how the mighty have fallen over the last three years. Brocade may still be No.1 overall in the switch market but no longer overwhelmingly so. More damning is that a total newcomer to the market, Cisco, is more competitive in the increasingly important director segment than Brocade, according to International Data Corp. numbers. And Cisco has managed to forge ties with EMC Corp. and other OEMs that Brocade once banked on to keep Cisco out of the market. The first version of EMC's highly anticipated Storage Router, expected later this month, will be based on a Cisco switch. Brocade's version of the product won't appear until some time later.

Meanwhile, Brocade announced this week that it will miss its earnings this quarter by $10 to $12 million. It blamed the miss on a weak month, lower-than-expected enterprise spending and longer sales cycles. But Wall Street analysts across the board say Brocade's problems run much deeper.

"We believe that competition from Cisco Systems, management distraction from the SEC [Securities and Exchange Commission] investigation, the new CEO learning how to manage the entire business and a lack of any material near-term catalysts are the real underlying issues," says Shebly Seyrafi, research analyst with Merrill Lynch.

The SEC is looking into an internal audit Brocade conducted last year that focused on how the company handled stock-based compensation. During the course of the review, Brocade determined that the way in which it accounted for stock option grants was incorrect and required a restatement. Brocade CEO Greg Reyes stepped down immediately after the audit in January, 2005. He has since resigned from his position on the board, too.

If Brocade can get through this investigation and get on with its job of building innovative and useful storage networking products, maybe then it can recapture some of its former leadership. After all, there are a lot of Brocade shops, and most people would prefer root canal therapy without anesthesia to swapping out switch fabrics.

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