Brocade Communications Special Meeting (2017)

Brocade Communications (BRCD) held a special meeting at the Santa Clara Hyatt on January 26, 2017 to approve a merger.  The hotel offered pastries, a fruit platter, and beverages, including mineral and flat water.  After the formal portion of the meeting, Brocade didn't bother opening the floor to any shareholders until I asked why they weren't soliciting feedback or questions.  Apparently, Brocade believes that special meetings aren't appropriate venues for shareholder questions, but deigned to include them after my request. You may be wondering, "Why bother having shareholders attend if you won't answer questions from them?"  Such a question assumes a minimum IQ and an ability to understand logic, two items we'll see might not actually exist in Brocade's corporate repertoire.

My question was about privacy and security vulnerabilities in Brocade's technology.  With the NSA's activities becoming well-known post-Snowden (see Citizenfour for more details), I asked whether Brocade allowed backdoors in its products or had been solicited by the NSA to do so.  Brocade appeared startled by the question and told me they couldn't answer it.  I replied, "So you can neither deny nor confirm the existence of backdoors in any of your products?"  Brocade, smart enough to realize the trap I'd laid, still wasn't courageous enough to answer the question, gave a convoluted answer and basically said it wasn't the type of question appropriate at the special meeting.  (Because something like privacy vulnerabilities couldn't possibly be relevant to a merger or its price, right?)  I walked out, saying, "There's no leadership here."

Two men affiliated with the company approached me after the meeting and asked if I really expected the company to answer questions that might jeopardize the merger.  "Today is precisely the time that such questions are relevant, because shareholders and lawyers on both sides deserve to have full information before approving or voting on the merger," I said.  Meanwhile, I was thinking, "Why is it my problem if the teams' lawyers didn't do their due diligence properly?  Why am I bound by their limited scope?"

I repeated my insistence that corporate America as well as the country at large was diminishing because of a lack of leadership and integrity.  I'm willing to bet each of the directors or executives silently sitting at the table during my questions had undergraduate or graduate degrees from schools that advertise they're creating leaders.  I recalled one of my favorite scenes from Scent of a Woman: "'Cradle of leadership.'  Well, when the bow breaks, the cradle will fall. And it has fallen here, it has fallen!"

Brocade's refusal to answer my questions was steeped in no law--only cowardice.  Once the formal portion of the meeting concludes, the informal part isn't necessarily regulated by specific laws other than what the company decides or what is presented in the notice.  The company should of course be consistent from year to year to avoid being accused of discrimination or other issues, but with respect to the informal portion of the meeting, I know of no "Brown Act" equivalent that limits questions.  At other shareholder meetings, I've seen people ask questions about CEO's personal lives and even sing "Happy birthday" to one.  And yet, here I was, being told by Brocade that they couldn't answer my questions, because questions about the company's technology weren't within the scope of the special meeting's purpose.

Let me repeat that--from what I understand, Brocade refused to answer shareholder questions on its own technology's vulnerabilities because it didn't believe that such information was relevant to the merger price or merger agreement.

The first page of Brocade's December, 20, 2016 "Notice of Special Meeting of Stockholders" states, "We are holding the meeting for the following purposes... To transact any other business that may properly come before the special meeting, or any adjournment or postponement of the special meeting, by or at the direction of the board of directors of the Company."  [Emphasis added.]  Who signed the statement? Ellen A. O'Donnell, Senior Vice President, General Counsel and Corporate Secretary.

Who refused to answer my questions because she felt they weren't appropriate for the special meeting?  It appeared to be Ellen A. O' Donnell, Esq., graduate of Stanford University and Loyola Law School.

That's not even the best part.  Brocade's own 10K from 2015 states, "Customers have become increasingly sensitive to government-sponsored surveillance and may believe that, as a U.S.-based manufacturer, Brocade’s equipment contains 'backdoor' code that would allow customer data to be compromised by either governmental bodies or other third parties. As a result, customers may choose not to deploy Brocade networking products, which could negatively impact Brocade’s business and financial results."  Note the language above doesn't admit or deny the existence of backdoors--it just states that customers might believe they exist.

I now have two further questions: 1) What is Brocade trying to hide about its cooperation with government surveillance requests?

2) Should you, as a consumer, use the services of any company that buys Brocade products when you might be giving your network information or data to the U.S. or foreign governments?

(c) Matthew Rafat

Disclosures: I own a non-substantial number of shares of Brocade (BRCD).

Update on Brocade

On July 23, 2010, I wrote: "I own Brocade (BRCD) shares. As of July 23, 2010, Brocade is my largest individual stock holding." The original post is HERE. 

On July 23, 2010, BRCD was trading around 5.03. BRCD declined further over the next few weeks, dropping to around 4.70. I continued to buy on the way down, even as I doubled my workout routine to deal with the stress. 

On September 2, 2010, BRCD went up to 5.64. I sold most of my shares around 5.57. 

Although it seems counter-intuitive, I get very anxious when a stock pops over 20% in less than a month. With my "two in the hand is better than one in the bush" mentality, I sold almost all of my BRCD stock. BRCD is no longer my largest holding, and I no longer have an opinion about the direction of its stock price. However, I continue to think a "horizontal acquisition" (when a competitor buys out its competition or supplier) would be ideal for EMC and BRCD, especially because the risk of a DOJ anti-trust objection appears negligible. (Strangely enough, rumors are floating now about EMC being a takeover target, even though very few companies could afford to buy EMC.) 

It's puzzling to me that almost no one has suggested EMC as a potential acquirer of BRCD. Dell (DELL), Hewlett-Packard (HPQ), IBM, and Oracle (ORCL) are usually mentioned in every story about Brocade--even though Larry Ellison once said he wasn't interested in Brocade, and HPQ might not be too keen on making another acquisition so soon after its 3PAR (PAR) deal. 

Regardless of the potential synergies, a Brocade buy-out isn't a sure thing. For example, a company interested in Brocade may decide to look at QLogic Corp. (QLGC) instead. Also, Brocade's Board of Directors may demand a buyout price beyond what an interested acquirer would consider fair or reasonable. And of course, Brocade may simply decide to move forward on its own. 

I do know one thing, though--with so much cash on their books, tech companies are sick of getting close to 0% for it. Most tech companies--mindful of the boom/bust cycles common in the technology arena--usually hoard cash and pay either no dividend or a paltry one. As long as interest rates remain low, many tech companies will be looking to grow through acquisitions. Good luck to them, and good luck to Brocade and its CEO Michael Klayko. 

Prior to Brocade, Mr. Klayko held positions at EMC and IBM. 

Disclosures: I continue to own some Brocade (BRCD) shares, but my holdings may change in the future.

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Brocade Shareholder Meeting (2010)

I attended Brocade's shareholder meeting on April 12, 2010. The company offered shareholders coffee, tea, water, and some of the best chocolate chip cookies I've ever tasted. 

At the front of the room were Tyler Wall, Dave House, Mike Klayko, and Richard Deranleau. This year, more Board members appeared in person, so the meeting seemed more fully attended. CEO Klayko delivered an oral presentation accompanied by a slideshow. Below are the main points from his presentation: 

• Network traffic continues to increase. 

• The amount of digital data is already massive--if printed in hard copy, it would form a line from Earth to Pluto and back twenty times. 

• There are over 8,000 laws on data regulation, which is an excellent situation for storage and storage area networking companies. For example, by law, financial companies need to maintain several copies of all emails sent. 

• People are afraid of the word, "delete," and will err on the side of keeping everything. 

• By 2015, consumers are expected to own 15+ billion networking devices. 

• Qzone is the Facebook of China and reaches more users than Facebook. [More consumers will be storing, publishing, and accessing information online not just in the United States, but worldwide.] 

• Cloud computing appears to be a sustainable trend. Salesforce.com (CRM) is a good fit for Brocade, and CRM also uses Brocade technology. 

• 60 to 70% of business costs typically revolve around employees, which is why corporations laid off so many employees last year; however, the workload continues to grow, and at some point, companies must re-hire employees to keep up with demand. 

• Brocade offers "unmatched simplicity, investment protection, non-stop networking, and optimization." 

After the presentation, it occurred to me that Brocade had delivered an excellent presentation about the overall marketplace but not about its own company. For example, there was no information showing how Brocade would be able to effectively compete with larger players such as Cisco (CSCO). The presentation didn't have information about Brocade's market share; specifics about Brocade's competitive advantages; new products; new streams of revenue; cost reductions, or anything else that would impact earnings per share. 

I remarked that I thought the presentation was great, and I felt like running out and buying shares in the major players in the data business--such as IBM, HP, and Cisco. In short, I didn't see why I should buy Brocade over Cisco or other technology companies that handle data. I also compared Brocade to the independent coffeeshop on the corner with Starbucks/Cisco opening franchises left and right. How did Brocade plan on competing with Cisco? 

CEO Klayko said that such comments had been made to him for the past ten years. He said that Cisco has been a "ten year conversation," and "we're still here." He then generally mentioned Brocade's "expanding product portfolio," and then briefly differentiated Brocade from Cisco by saying that Cisco believes in "vertical integration" while Brocade believes in "horizontal integration." 

Another shareholder asked about Foundry Networks, a previous Brocade acquisition. He said that Brocade had a good product line, but sales and marketing needed improvements. He appeared to have information about sales in Europe, and he indicated that Cisco was hammering Brocade overseas. "Nobody knows about you," he remarked. CEO Klayko responded by saying that he agreed that Brocade needed better branding, and part of the failure was because Brocade was a Business-to-Business (BtoB) company, not a consumer company. He agreed that Brocade needed to build on sales, but also said that half of Brocade's business already comes from outside the United States. 

And just like that, the meeting was over. I introduced myself to the shareholder who mentioned European sales, and he told me that Brocade dominated the storage area networking space. Brocade apparently has 75% market share compared to Cisco's 17%. Somehow, this gentleman realized how to sell Brocade more adeptly than the company's CEO. 

Brocade seems to have positioned itself as the alternative to Cisco, which is a horrible sales pitch. Pepsi doesn't walk around saying, "Try us when you're tired of Coke." And if someone ever told Pepsi's CEO that she should market Pepsi as a cheaper, more simple version of Coke, she would probably open a Montgomery Burns style trapdoor while hissing, "Release the hounds." 

Incredibly, Brocade's marketing strategy seems to be based on the idea that Cisco ought to have a competitor, so why shouldn't it be Brocade? Brocade's management and Board of Directors really ought to talk to RedHat and other Linux-based operating systems purveyors. Ask them how that type of sales pitch worked against the Cisco of software, Microsoft (MSFT). 

How could a company be so clueless when it comes to basic marketing strategy, especially in an increasingly global environment? Well, I lost interest in Brocade stock after last year's annual meeting. (You can read my long-winded rationale HERE if you're interested.) I sold my shares, thinking that a potential buyout wasn't enough justification for holding onto Brocade shares. Now, it's quite possible that someone will eventually buy Brocade. About two years ago, Brocade removed its "poison pill" provision, basically alerting the world that it was open to a takeover. (Also, maybe Carl Icahn will show up. He did make some money on Yahoo, didn't he?) 

Also, I like CEO Klayko--he's down-to-earth, diligent, not arrogant, and clearly a good guy. Yet, despite all of its good points, Brocade must realize that Wall Street will never give it any respect until it tries to position itself as a leader in the industry. No one wants to buy products from a company that positions itself as Cisco-lite and talks about its major competitor in respectful, almost hushed, tones. (Contrast Brocade's comments about Cisco with Salesforce.com's CEO's comments about its competitor, Oracle. Slight difference, no?) 

If Brocade wants its stock price to increase, it needs to grow some cojones and improve diversity in the upper ranks. Right now, Brocade runs like a company that doesn't mind being in second place. Absent some major changes, Brocade will continue to be the nerd at the high school while Cisco struts around as the cool kid. Thus, Brocade can talk all it wants about how much better its products are from a techie standpoint, but at the end of the day, it's Cisco--with its massive cash, effective marketing, more aggressive management, and better management diversity--that will get the beautiful fans. If I had to give Brocade's CEO a pep talk, here's what I would tell him: 

I don't want you to be the guy in the PG-13 movie everyone's really hoping makes it happen. I want you to be like the guy in the rated R movie, you know, the guy you're not sure whether or not you like yet. You're not sure where he's coming from, okay? You're a bad man. You're a bad man, Mikey. You're a bad man. You're a bad man. 

Mr. Klayko: I'm really hoping you can make Brocade into the bad man on the block. You're so money, but you don't even know it. 

Disclosure: I bought more BRCD shares after the meeting, but only because I expect IBM to buy out Brocade at some point.

Brocade Communications Shareholder Meeting (2009)

Brocade Communications Systems, Inc. (BRCD) had its 2009 annual meeting on April 15, 2009. The day after the meeting, Brocade announced closer ties to IBM. There was no informal presentation. 

Although the meeting itself was bare bones, Brocade's Shareholder Relations team did a fantastic job. I don't think I've ever praised a company's investor relations team before, but Brocade's team deserves special recognition. 

First, they used a portable miniature microphone. A company representative went around the room offering the microphone to whomever had the floor. You would be surprised at the number of companies which use no microphones at all, forcing shareholders to speak very loudly or requiring executives to repeat questions. Most large shareholder meetings have one or two standing microphones where people can stand to ask questions. This works well for larger meetings. For smaller meetings held in a conference room, a portable microphone works best. 

Second, the food was fantastic without being ostentatious. In these hard times, companies need to balance saving shareholder money with projecting a strong, healthy image. No food or coffee at the annual meeting indicates a company that either doesn't care about its shareholders or is trying to cut costs to the bone. Brocade had coffee and mineral water--the basics--but it also had some of the best chocolate chip cookies I've ever had. These cookies were so thick, they looked like scones. If my mother hadn't taught me basic manners, I would have stuffed about 20 of them in my pockets. I asked someone who made the cookies. She told me it was Gunther's Catering. 

I called Gunther's and confirmed they made the cookies. He said it was his mother's recipe, and they baked them fresh every day. The company has been around for 39 years and specializes in wedding receptions. If you like chocolate chip cookies, get thee to Gunther's. 

Lest you think it was just the cookies that won my heart, I assure you that's not the case. Shareholder relations personnel handled themselves professionally. They did not treat me or other shareholders like unwanted guests crashing an internal company party. You'd be surprised at how poorly many shareholder relations treat ordinary shareholders--read my Visa post, for example, where a shareholder relations person tried to stop me from taking a picture with the CEO, who was actually happy to have his picture taken, and then demanded my contact information. 

Lacking a presentation, the meeting would have been over had shareholders not asked questions. CalSTRS and CalPERS representatives appeared at the meeting to check on their shareholder proposals. Prior to voting, the company did not allow any comments to be made on their proposals. A shareholder attempted to make some comments, but Brocade's executives refused to allow him a microphone. Their refusal seemed unprofessional, because disallowing comments on specific proposals stifles the flow of potentially unbiased information to shareholders. Although most companies will tell you to make your comments at the end of the formal meeting, polls are closed by that time. Strike one against Brocade's management team. 

After the formal portion of the meeting concluded, the California representatives asked for a preliminary tally of the votes. Brocade didn't have one. I've never seen this happen before at any major company. Strike two against Brocade's management team. 

I asked a few questions. I asked how the company was managing the integration of Foundry Networks (FDRY). CEO Michael Klayko said the acquisition was going well. I asked what specific gap in Brocade's (BRCD) products the acquisition fulfilled. Many times, companies will acquire another company to boost revenue but will lack a real need for an acquisition. CEO Klayko said that Brocade found it cheaper to buy the company than to create the technology in-house. Foundry, he said, had "more connectivity products." Also, Foundry had just released a new chipset/product the prior Tuesday, showing that the acquisition was going smoothly. 

I asked what problems, if any, Brocade had discovered in the course of integrating Foundry. CEO Klayko said that Foundry Networks' distribution channels needed work, and its "marketing was suspect." Brocade's marketing, however, was very good, and that's why the two companies would work well together. 

I asked how Brocade expected to compete with Cisco (CSCO) and Nortel (NT). Here's where CEO Klayko shined. He said that Nortel might not be the best example to raise, because of its bankruptcy. As far as Cisco--Brocade's main competition--was concerned, CEO Klayko said that Brocade offers "cost advantages." In other words, Brocade offered similar products but at a lower cost. CEO Klayko also said the marketplace wants an alternative. Only near-sighted customers want to encourage a monopoly, because maintaining the status quo would allow Cisco to keep its high margins and relatively higher prices. Another shareholder, who worked for an investment firm, asked about analyst reports relating to IBM. 

CEO Klayko said there were lots of rumors out there and deflected the question. (The very next day, IBM and Brocade announced they would be working together on various products.) 

Another shareholder asked about Brocade's real estate strategy (buying vs. leasing property) and received a vague answer. 

Another shareholder was unhappy about the lack of a presentation. He also criticized the in-person absence of 50% of the directors. In what was the most memorable line of the day, he told Brocade's management, "Make us feel like you give a damn about us [small shareholders]." 

CEO Klayko responded that all the directors were present, but some were present by teleconference. He told this shareholder that he'd seen him present at various meetings throughout the year, so the company did communicate with its shareholders. I may have misheard the next response, but the shareholder responded that the only reason he was able to get access to those meetings was as a client of a brokerage firm. In my mind, if any company is restricting or selectively disclosing material information only to analysts or major shareholders, it would be violating Regulation FD. Please note: I do not have any information about whether any violation of Regulation FD is occurring, and I am not making any allegation of securities law violations. I would be very upset, however, if any company communicated relevant information only to major shareholders post-Regulation FD. 

I asked the CEO about complacency. I asked what the CEO was afraid of or concerned about. The CEO gave me a five item list: 

1. Access to capital. 

2. New technology (which makes current technology obsolete). 

3. Acquisitions that change the competitive landscape. 

4. Innovative quality (how to maintain quality). 

5. Cost (keeping costs low to attract customers). 

CEO Klayko also talked about the "entitlement mentality." He seemed to be channeling one of my favorite CEOs, Cypress Semi's (CY) T.J. Rodgers. 

I asked about various memorabilia in the room, which included a jersey from The City that Shall Not be Named (at least according to ESPN's Bill Simmons) and a signed Hootie and the Blowfish guitar. The CEO didn't know about the stories behind any of the memorabilia. 

Here's where things got a little interesting. I pointed out that Brocade had presented itself as an all-white, all-male company. All four persons at the front of the room representing Brocade appeared to be older Caucasian men. There's nothing inherently wrong with that, and diversity does not guarantee success. At the same time, almost all successful global companies present themselves as non-monolithic. (Pepsi (PEP) and Coke (KO) are way ahead of the game in this aspect.) I also said the executive team's lack of diversity was strange because the company was based in Santa Clara County, where 40% of the population is born outside the U.S. 

One of America's greatest attributes is its ability to project an open, tolerant image, which has attracted many ambitious, diverse people. As a result, we have the Blackberry (Canadian); Yahoo (Taiwanese); Google (Russian); eBay (French Iranian); and so on. Companies and countries that fail to project an open, tolerant image will be disadvantaged as world economies become more globalized, allowing talent and money to move elsewhere. In a nutshell, Brocade appeared to be violating Rafat's Law of Diversity. 

When I mentioned Brocade's appearance of having a 100% native-born Caucasian male executive team, the one and only female on the Board of Directors, Judy Bruner, raised her hand with a smile. Ms. Bruner is probably a great person. She received her MBA from Santa Clara University, my alma mater, and Santa Clara University strives to produce ethical, well-rounded graduates. However, when the only female on a company's Board happily raises her hand to demonstrate diversity, it's hard not to think that the corporate culture is irretrievably monolithic. From my perspective, having only one female on an entire Board is not cause for happiness or active disclosure. Even North Dakota's MDU Resources, Inc. (MDU) has more females on its board (25% of its directors are female) than Brocade. Thus, to me, Ms. Bruner's reaction--immediately identifying herself as the one and only non-male Director, instead of letting the CEO acknowledge the company's lack of diversity--felt strange. By the way, with the exception of perhaps three or four people in the entire room, everyone else present appeared to be native-born Caucasian also, which isn't an inherent problem, but still unusual in a diverse city like San Jose, California. 

CEO Klayko did not acknowledge his management team's lack of diversity. Instead, he said that we needed to create better educational opportunities here in the United States, and we were falling behind in science and math. He said Brocade was participating in the Tech Challenge, which encouraged children to pursue careers in math and science. In other words, Brocade was actively working at the local level to attract diversity. CEO Klayko joked that he was recruiting [minorities] at the 5th grade level. In response to my comment that we lived in a county that where 40% of the residents were immigrants, he said Brocade was a global company, not a local one. 

Unfortunately, his response confirmed my belief that Brocade's management culture is monolithic. Most studies show that Caucasians are only 20% of the world population. Assuming a 50/50 split in females and males, only 10% of the world contains Caucasian men--which indicates the CEO's response wasn't statistically sound. Again, there's nothing wrong with having 90% or 100% of any race on a management team. In fact, after the meeting, Investor Relations pointed out that of the 8 directors, one was a female and one was Indian--not a bad percentage. It's culture I am concerned with, not race. From what I saw at the meeting, Brocade's management team seems to lack cultural diversity. Strike three against Brocade's management team. After the IBM news was released publicly, I sold all but one of my shares. If Brocade works well with IBM, its shares may go higher in value; however, Brocade's relatively high debt load may inhibit its shares' forward progression. 

I really enjoyed listening to the CEO. He appeared energetic, strong-willed, charismatic, opinionated without being crass, diligent, goal-oriented, and knowledgeable--in other words, someone born to be a leader. I could immediately see why he ascended the corporate ranks. At the same time, passionate CEOs generally need a Board and executive team willing to speak up and provide a voice of caution. I'm not sure that's going to happen. Strong-willed leaders tend to unintentionally crowd out dissent, especially when their companies lack a substantial number of women in the upper ranks. With only one female and one Indian-American on the Board, I don't see Brocade's current management team as being sufficiently diverse. Perhaps I am wrong. On my way out, I passed by a room with many busy workers. Everyone in that room appeared to be of Indian descent. 

Note: Brocade has a blog. CEO Klayko's most recent post is here. The first line of his post is this: 

We are a nation and an industry curled up in the fetal position. 

It's hard not to like someone so direct, passionate, and intelligent.