Corporate network storage company Brocade agreed to buy rival McData in a $713 million stock deal on Tuesday, putting it in better position to compete against industry giant Cisco Systems.

All three companies, are key providers of enterprise storage-area-networks (SAN) switches and directors, and have relationships with many of the key providers of storage-arrays in the IT services sector, including Sun Microsystems, EMC, and IBM.

With McData now absorbed by Brocade, the combined company and Cisco will be the fiber channel switch segment's two largest players.

McData's Strained Past

McData has struggled competing against Brocade and Cisco. Brocade leads both Cisco and McData by a wide margin in the total market for storage switches, according to Dell'Oro Group.

In the first quarter of 2006, Brocade led the total SAN switch market with $178.5 million in sales, followed by McData with $107.8 million and Cisco with $79 million.

In the high-end modular switch market, Brocade has been coming on strong as well. In the first quarter of 2006, according to Dell'Oro group, Brocade claimed second place for the first time in six quarters with $68.6 million in revenues. McData led with $76.4 million, and Cisco came in third with $64.7 million.

McData has warned that that it expects to report revenue of $150 million to $152 million for its second quarter, down from the company's expected range of $170 million to $180 million. McData attributed the lag to weak sales in its high-end products.

Baird analyst Daniel Renouard said in a research note that McData's weakness is not totally surprising, given recent results from EMC and IBM, and likely share loss due to lack of 4Gb director.

A United Cause

Buying McData turns a competitor into an integrated ally with a broader array of hardware and software, allowing it to compete more effectively against the competition.

Though Cisco trails the two companies in market share in SAN and switch technologies, the company is a relatively new entrant. However it brings brand recognition and capital from its dominant router businesses.

Cisco's aggressive market entry, into the fiber niche among other factors, has created an increasingly challenging industry structure for the incumbent players in recent years, according to Credit Suisse's Andy McCullough.

Given Brocade's market share momentum the past year and Cisco's increasing presence, the segment was becoming a situation of three's a crowd, JPMorgan analyst Mark Moskowitz said in a note to investors.

In our view, our concerns over the economics and competitive landscape lose some weight when considering the effects of removing McDATA from a segment more suited for two major players.

Brocade chief executive officer Michael Klayko shares the same sentiments.

This combination will accelerate the pace of innovation [and] enable us to build stronger relationships with our customers and partners, allowing the company to to compete more effectively.