Force10 Deal Could Sting Brocade, Juniper

If the Dell Technologies (Nasdaq: DELL) acquisition of Force10 Networks Inc. closes, the Ethernet growth prospects at Brocade Communications Systems Inc. (Nasdaq: BRCD) and Juniper Networks Inc. (NYSE: JNPR) could be collateral damage.

Both had OEM deals with Dell, to help them join the rush to outfit next-generation data centers. Now, Dell is planning to supply some of its own high-end networking gear. It's similar to the way Cisco Systems Inc. (Nasdaq: CSCO) began supplying its own servers, annoying IBM Corp. (NYSE: IBM) and especially HP Inc. (NYSE: HPQ). (See Dell to Acquire Force10 and HP Picks a Fight With Cisco.)

Brocade's case is getting more attention, because Brocade was supposedly the company Dell wanted to buy. But it was also planning to resell Ethernet switches through Dell on an OEM basis, a relationship that Force10's presence would weaken. (See Why Dell (Maybe) Likes Brocade and Brocade, Dell Team Up.)

"Dell was a small part of Brocade's Ethernet business but represented a large growth opportunity," analyst Mark Sue of RBC Capital Markets wrote in a research note Wednesday morning. "Brocade's Ethernet segment is on run rate of [about] $500M/year and represented a disproportionate amount of next year's growth relative to FibreChannel."

Same thing goes for Juniper.

"This purchase by Dell almost ensures that Juniper's business with Dell will never ramp," analyst George Notter of Jefferies & Co. Inc. wrote in a note published Wednesday. Dell had only begun selling Juniper's EX line of switches on an OEM basis. (The companies expect that to happen by October.)

For Juniper, Ethernet switches have been a growth vehicle, analyst Simon Leopold of Morgan Keegan & Company Inc. wrote Wednesday. Switch sales grew by 95 percent in 2010, although they still make up less than 10 percent of Juniper's revenues.

So, neither Brocade nor Juniper should see much effect in their revenues. What's gone is the potential for growth from the Dell OEM deals.

There might be a more broad problem lurking, though. Sue is thinking Ethernet switching revenues could shrink this year as competition intensifies.

Big picture
It's a thesis he'd been pursuing already. As the number of switch ports sold grows 9 to 12 percent during this year and next, Sue expects prices to fall as Arista Networks Inc. , Brocade, HP and Juniper all try to grab from Cisco's dominant market share. (Cisco held 64.9 percent share during the past four quarters, according to calculations from Infonetics Research Inc. and Morgan Keegan.)

"We project that 10Gbit/s ports, which are now selling for less than one-fifth the price 10 years ago, may see the most accelerated price decline," he wrote in a note issued Monday morning. "Regular 1Gbit/s ports in modular and fixed configurations may decline in price by 10 percent or more."

That's particularly bad news for Cisco. "Most data networking switching vendors on average have gross margins of 45-55 percent, which implies that Cisco, at 63.9 percent corporate gross margins, has the most to lose as pricing competition intensifies," Sue wrote on Monday.

In the time since he wrote that, there's been not only the Dell/Force10 deal, but the Intel Corp. (Nasdaq: INTC) agreement to acquire Fulcrum Microsystems Inc. . (See Intel Seeks Ethernet Leverage With Fulcrum.)

Using Intel's distribution power, "Fulcrum may have the opportunity to become more prevalent and capture more value share, pushing margins lower for these large switch vendors," Sue wrote on Wednesday.

— Craig Matsumoto, West Coast Editor, Light Reading