Struggling to Compete, Extreme Networks Needs a New Home

Early this week, Extreme Networks warned that its financial results would fall short of expectations for the quarter that concluded on September 27. Instead of revenue of $80.4 million, which is what analysts had been forecasting, Extreme expects to report $66 million in revenue for its fiscal first quarter.

The company followed that discouraging news with an announcement of new modules for its BlackDiamond 8800 chassis switch. The new modules will enable a BlackDiamond chassis to handle wiring-closet, core, and data-center switching, giving the company a fully extensible networking solution in one box. That makes BlackDiamond a better investment for customers.

Would that Extreme were a better investment. The company blamed its latest market tribulations on “supply-chain constraints,” but some analysts thought Extreme was also on the losing end of intensifying competition.

In a press release announcing the downgraded revenue forecast, Extreme Networks’ president and CEO Mark Canepa said the following:

“Our supply chain was constrained during the quarter, impacting our ability to deliver product, close transactions and recognize revenue. Our North America business was particularly soft, as some deals were lost and others were delayed beyond the end of the quarter. I am disappointed that we did not execute to our advantage.

However, on a positive note, we expect to report that backlog and deferred revenue increased by approximately $6 million and total cash increased approximately $3 million for the quarter. We and our Board of Directors are committed to addressing the issues that produced these results. I look forward to giving a complete update on our earning release conference call. Further, we are anticipating giving guidance for our second quarter on the call.”

That call is scheduled for October 26, and a few investors and analysts are hoping the company might be in play before then as an acquisition target. In the analyst community, there are more than a few who believe the company is bedeviled by chronically poor execution.

Said Samuel Wilson of JMP Securities:

“We believe investors should be wary of Extreme until revenue and operating margins show consistent improvement.”

Wedbush Morgan analyst Rohit Chopra wrote:

“We believe the primary reason behind the revenue shortfall was poor execution and rapidly intensifying competition.”

Competitors cited by Chopra included Cisco Systems Inc., Hewlett-Packard Co., 3Com Corp., Juniper Networks Inc., and Brocade Communications Systems Inc. I definitely agree that Extreme takes a back seat to Cisco, HP, and Juniper, and 3Com is trying desperately to get back into contention in the enterprise-networking space in North America. Brocade’s switching products from Foundry Networks go up against those of Extreme in many accounts, too.

Most of its competitors are bigger than Extreme, with far more resources and at their disposal. That means they’re in a better position to develop product enhancements and extensions and to expand their marketing and sales programs. Some of Extreme’s execution problems can be attributed to its lack of corporate scale, though others resulted from obvious tactical missteps.

One can’t help thinking that the company would be better off in the hands of a bigger player. QLogic, a vendor of Fibre Channel adapters and switches, has been mentioned as a potential acquirer, but I’m not sure that’s the best home for Extreme, even if QLogic were to buy Extreme in the hope of fattening itself up as a subsequent acquisition candidate.

That sort of maneuvering is too convoluted. It would be better for Extreme if it made one stop instead of two on the acquisition trail.

When will such an acquisition occur? Well, that’s hard to say. The answer depends on the need of the acquirer, the price said acquirer is willing to pay, and the price Extreme is willing to accept. With its stock down this week and its market capitalization at $241 million, Extreme is priced to sell, even with an acquisition premium added to the final sum.

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