New Issue: Brocade Communications Systems (BRCD) $500 million Convertible Senior Notes Due 2020

Brocade is an established networking company. The $500 million convertible issue gets a lackluster overall HOCS of 54.   The score is held down by the low growth number, which is a reflection of a stable established company, but it is helped by the robust safety score (sort of the opposite of a biotech).  Our HOCS slash line measures 54 Overall / 45 Growth / 71 Safety based on price-talk midpoints believed to be 1.625% up 32.5% on a five-year bullet.  We think the overall HOCS score, while properly highlighting the relative lack of growth, understates the value of this bond in balancing aggressive portfolios—again, something you can see in the safety score.  The bond has reasonable optics and is likely, given the company’s convertible-issuing history, to perform well early.  The overall score, though, suggests investors should be disciplined and avoid paying up to establish a position.

Brocade is a leading supplier of networking hardware and software, including Storage Area Networking (SAN) solutions and Internet Protocol (IP) networking solutions.  The company competes against several other large, well-established companies, including Cisco, Alcatel-Lucent, HP, and Lenovo.  BRCD made a small acquisition in September when it bought Vistapointe, a start-up focused on developing software based, carrier-grade network visibility and analytics solutions for mobile network operators.  The purchase price was $16.9 million in cash.  It is possible the company is contemplating additional tuck-in acquisitions. 

The company is a strong and consistent positive free cash flow generator, with $596 million in positive free cash flow generated over the last twelve months.  Management made a commitment to return at least 60% of free cash flow to shareholders.  The company initiated a dividend for the first time in fiscal year 2014, paying out $30 million.  Stock repurchases have accelerated and totaled $335 million during the same time period.  Management remains committed to this goal, so we can expect more of the same. 

A portion of the proceeds from the new convertible bond offering will be used for stock repurchases, up to $100 million, getting the company off to a quick start in 2015.  Most of the rest of the proceeds will be used to redeem the entire $300 million of 6.875% senior secured notes due 2020.  We view this as a wise choice, replacing high rate secured debt with a low interest rate convertible bond.  The company is also terminating its $125 million secured revolver.  Nothing had been drawn on the line in several years.   

The other debt outstanding is $300 million of 4.625% senior notes due 2023 and about $5 million of capital leases.  Pro-forma leverage is a moderate 1.2x.  Liquidity is very good with pro-forma cash of $1,255 million.          


Pro Forma Summary Statistics:

Cash: $1255 million

Total Debt: $805 million

LTM EBITDA: $667 million

LTM Cash Flow: $596 million

Total Market Cap: $4,920 million

Debt/EBITDA:  1.2x