TEXT - S&P rates Brocade Communications Systems senior notes

Wed Jan 16, 2013 10:50am EST

Overview
     -- U.S. networking equipment manufacturer Brocade is issuing $300
million in senior unsecured notes maturing in 2023 to refinance its existing
$300 million of senior secured notes. 
     -- We are assigning our 'BB+' issue rating to the company's senior 
unsecured notes.
     -- We are also affirming our 'BB+' corporate credit rating on the company.
     -- The stable outlook reflects our expectation that the company will 
maintain its "intermediate" financial risk profile, as evidenced by a 
conservative credit profile and consistent cash flow generation.
Rating Action
On Jan. 16, 2013, Standard & Poor's Rating Services assigned its 'BB+' issue 
level rating and '3' recovery rating to Brocade Communications Systems Inc.'s 
new $300 million senior unsecured notes. The '3' recovery rating indicates our 
expectations for meaningful (50% to 70%) recovery of principle in the event of 
payment default.

We also affirmed our existing ratings on the company: the 'BB+' corporate 
credit rating and the 'BBB' issue-level rating on the company's $300 million 
senior secured notes due 2020. The '1' recovery rating on the senior secured 
notes remains unchanged and indicates expectations for very high (90% to 100%) 
recovery of principle in the event of payment default.

Rationale
The ratings on San Jose, Calif.-based Brocade Communications Systems Inc. 
reflect Standard & Poor's expectation that the company will maintain its 
"intermediate" financial risk profile, as evidenced by a credit profile we 
consider conservative and consistent cash flow generation. We view Brocade's 
business risk profile as "fair," reflecting its strong presence in the mature 
core storage area network (SAN) segment and a small market share in the much 
larger and highly competitive Ethernet switching segment.

Brocade is a provider of networking solutions with a strong position in the 
SAN business, where it has a market share of close to 70%. The installed SAN 
base provides a reliable maintenance revenue stream. Nevertheless, growth in 
SAN revenue is likely to be modest, and SAN remains vulnerable to technology 
changes that could affect the economics of this segment. Brocade entered the 
Ethernet switching business via its acquisition of Foundry Networks Inc. in 
2008. That segment accounted for about 28% of product revenues in fiscal 2012. 
Customer concentration remains high, with three original equipment 
manufacturers (OEMs) -- International Business Machines Corp., Hewlett-Packard 
Co. (HP), and EMC Corp. -- accounting for 47% of total overall sales.

Brocade benefits from the underlying trend toward network convergence as the 
proliferation of video, wireless products, and IT infrastructure 
virtualization lead to increasing demand for networking products. Given the 
limited size ($2 billion) and relative maturity of the SAN market, it is the 
Ethernet switching business that offers Brocade the greater potential for 
growth. However, Ethernet switching is a far larger market ($20 billion) than 
SAN, and Brocade has a small market share in a segment dominated by Cisco 
Systems Inc., a much larger competitor with far greater financial resources. 
In addition, growing competition from companies such as Juniper Networks Inc. 
and HP is likely to keep average selling prices under pressure.

Brocade continues to deliver mixed results, with consistent growth in the SAN 
segment offset by uneven performance in the Ethernet switching segment. 
Despite macroeconomic headwinds and competitive industry dynamics, we expect 
Brocade to drive low single-digit revenue growth overall in fiscal 2013 as SAN 
growth remains stable and the Ethernet switching segment resumes growth via 
new product rollouts. The EBITDA margin is expected to remain flat to slightly 
lower as we assume growth in the lower margin Ethernet switching segment. 

In our view, the financial risk profile is intermediate. During fiscal 2012, 
Brocade voluntarily repaid the remaining $190 million under its term loan 
facility. As a result, adjusted leverage now stands at 1.2x, and funds from 
operations to debt is about 73%, which we consider strong for the rating. Free 
operating cash flow (FOCF) has also expanded significantly due to both 
improved cash flow from operations and lower capital spending. We note that 
the current rating incorporates capacity for adjusted leverage to temporarily 
rise to near 3x to allow for earnings volatility or increased shareholder 
returns.

Liquidity
We consider Brocade's liquidity profile to be "adequate" under our criteria, 
with sources of cash likely to exceed uses for the next 12 to 24 months. Cash 
sources include cash and cash equivalents of $713 million as of Oct. 27 2012, 
more than half of which is held overseas; full capacity under a $125 million 
revolving credit facility; and expected positive FOCF in the intermediate 
term. We expect major uses to include capital expenditures near $80 million in 
fiscal 2013 and share buybacks to manage dilution.

Our assessment of Brocade's liquidity profile incorporates the following 
expectations, assumptions, and factors:

     -- We expect sources of liquidity will exceed uses by 1.2x or more and 
also expect that net sources would be positive, even with a 15% to 20% drop in 
EBITDA.
     -- Because of the company's adequate discretionary cash flow and cash 
position, we believe it could absorb low probability, high impact shocks, and 
that it has adequate access to capital markets.
     -- Brocade has ample covenant headroom under its term loan facility.
     -- There are no near term maturities.

Recovery analysis
For the complete recovery analysis, see Standard & Poor's recovery report on 
Brocade to be published soon on RatingsDirect.

Outlook
The stable outlook reflects our expectation that Brocade's financial policy 
will remain consistent with an intermediate financial risk profile. Its 
current business risk profile -- specifically, challenging market conditions 
in the Ethernet switching segment -- limits a possible upgrade in the near 
term.

Although unlikely, we would consider a lower rating if the company pursues a 
more aggressive financial policy via a sizable debt-financed acquisition or 
shareholder returns such that leverage is sustained above 3x.

Related Criteria And Research
     -- Methodology: Business Risk/Financial Risk Matrix Expanded, Sept. 18, 
2012Methodology And Assumptions: Liquidity Descriptors For Global Corporate 
Issuers, Sept. 28, 2011
     -- 2008 Corporate Criteria: Analytical Methodology, April 15, 2008
     -- 2008 Corporate Criteria: Rating Each Issue, April 15, 2008
     -- 2008 Corporate Criteria: Ratios And Adjustments, April 15, 2008
     -- Use Of CreditWatch And Outlooks, Sept. 14, 2009
     -- Criteria Guidelines For Recovery Ratings, Aug. 10, 2009
     -- Key Credit Factors: Methodology And Assumptions On Risks In The Global 
High Technology Industry, Oct. 15, 2009Issuer Ranking: Global Technology 
Ratings, Strongest to Weakest, Sept. 27, 2012
     -- Top 10 Investor Questions For 2013: Global Technology, Dec. 5, 2012

Ratings List
Ratings Affirmed

Brocade Communications Systems Inc.
  Corporate credit rating          BB+/Stable
  Senior secured notes             BBB
    Recovery rating                1

Ratings Assigned
Brocade Communications Systems Inc.
  Senior unsecured notes
   $300 mil due 2023               BB+
    Recovery rating                3
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