McDATA Corporation

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McDATA Corporation

310 Interlocken Crescent
Broomfield, Colorado 80021
U.S.A.
Telephone: (72) 558-8000
Toll Free: (800) 545-5773
Fax: (720) 566-3860
Web site: http://www.mcdata.com

Public Company
Incorporated: 1982
Employees: 1,008
Sales: $399.7 million (2004)
Stock Exchanges: NASDAQ
Ticker Symbol: MCDT
NAIC: 334290 Other Communications Equipment Manufacturing

McDATA Corporation (McData) provides storage area networking (SAN) products and services that help large organizations build Global Enterprise Data Infrastructures (GEDIs), consolidating computer networks and tying together data centers that may be spread around the world. The company's main product is the director-class Fibre Channel switch, essentially a traffic director that connects mainframe computers to storage devices, or multi-mainframes to multiple storage devices. The switch creates a "dynamic" connection, a temporary point-to-point connection for data transfer. In addition, McData sells switch cabinets, SAN management and security software, and offers training and support services. Most of its sales are indirect, accomplished through a wide range of original equipment manufacturers, including Dell, EMC, IBM, Hitachi Data Systems, Hewlett-Packard, Sun Microsystems, as well as system integrators and distributors. Based in Broomfield, Colorado, McData is a public company listed on the NASDAQ.

Offspring of 1960s Storage Pioneer

McData is one of dozens of data storage companies that grew out of Storage Technology Corporation (STC), founded in Boulder, Colorado, in 1969 by Israeli immigrant Jesse Aweidi, an IBM engineer who convinced three colleagues to launch a company at a time when leaving IBM, which maintained a plant in Boulder where they worked, to form a startup was tantamount to treason. The founders were familiar with IBM's approach to the tape storage business and sensed there was an opportunity in the market. Their gamble paid off and inspired any number of workers at STC to start their own storage-related companies, which in turn spawned other companies. As a result, Boulder County became the center of the computer storage industry even after IBM relocated its storage development operation to Arizona.

One STC employee who caught the entrepreneurial bug was John F. (Jack) McDonnell, who attended California State University at Long Beach before working at Computer Communications Inc. and moving from California to take a position at STC in its networking division in 1980. Two years later, however, he found himself laid off when a project he was working on was cancelled. Rather than move out of state in search of employment, McDonnell and five of his out-of-work colleagues (Wil Behl, Jim Fugere, Bruce Walsh, Paul Lilly, and Gary Flauaus) decided to start a company to build their own data communications devices. That was the extent of the business plan they mapped out in McDonnell's garage in August 1982.

McDonnell became chief executive officer of the new company. It was only when he went to the Colorado Secretary of State's office to file the incorporation papers that he realized that he and his partners had neglected to name the company. He remembered that while he was at STC a secretary had labeled one of his projects "McDATA," a play on his last name. McDonnell submitted the name, never intending it to be anything more than a stop-gap choice. "We all agreed that we would find a really nifty name, some kind of clever acronym, later," McDonnell told the Denver Post in 2002. "But we never did. So here we are 20 years later still with that name that just popped up. We've kind of gotten used to it."

Operating on a shoestring, McData set up shop in McDonnell's garage, where the engineers developed the company's first product, cluster controls that linked computer terminals to mainframe computers even if the individual operating systems were not compatible. It was not long before McDonnell's wife, Pat, kicked them out of the garage and the company found accommodations in Gunbarrel, Colorado, six miles outside of Boulder, and soon became a tenant at Interlocken Business Park in Broomfield where the company would have room to grow. The founders raised the seed money among themselves, cashing in retirement funds and savings accounts, and taking out second mortgages on their homes. After a year money was so tight that McDonnell was on the verge of putting his house up for sale in order to meet payroll. Before that came to pass, however, he was able to attract $3.2 million in venture capital money in September 1983. In a second round held two years later, McData raised another $4.6 million. In 1984 the company introduced its first product, generating sales of $295,000, and in 1985 it showed its first profit.

McData enjoyed tremendous growth during its first five years. By the autumn of 1987 the company employed about 250 people and the space it leased at Interlocken grew from less than 10,000 square feet to nearly 120,000 square feet. Sales approached $30 million. In addition to cluster controllers, McData built multiplexers to allow a large number of terminals to share a printer and local area network (LAN) gateways. The products were sold primarily through distributors, available in 29 countries, but they were marketed under the name of others. In 1989 the company decided to sell products under the McData name directly to corporate computer users, hiring scores of sales and support people. Employment swelled to 500 by the end of the year. While the industry began to accept the products with McData's label, the transition to direct selling did not proceed as rapidly as hoped. As a result, in 1990 McData underwent a "resizing," as many workers were terminated.

Technology Changes Leading to 1990s' Restructuring

What was more important than sales channels to the future direction of McData were changes in technology and the marketplace. The demand for cluster controllers was fading as companies phased out systems that tied dumb terminals to mainframes in favor of networking personal computers. By November 1993 McData's workforce was reduced to just 140. With a change in strategy clearly in order, the company sold off its channel gateway product lines in March 1993. It also dropped the idea of direct sales to end-users, a poor idea given that the company was trying to sell into an already mature market, opting instead to sell to original equipment manufacturers. With the money received from the sale of its business, McData was able to invest in the development of what it called the Model 3 project, which was pursued confidentially in a collaborative effort with IBM. That product was the Escon Director. Denver Business Journal described it in October 1994 as "a piece of equipment that is half the size of a refrigerator and priced at about $250,000. It provides switching capabilities between the channels of mainframe computers and peripherals such as tape drives, hard drives and printers." The product also offered fail-safe backup systems to protect companies from the crippling loss of data. Under the terms of its agreement with IBM, McData would only sell the Escon Director to IBM, which would use the product in its own mainframes and sell it to other OEMs. IBM would soon account for 90 percent of McData's business.

In 1995 McData was purchased by IBM rival EMC Corporation for $235 million in stock. The leading provider of storage devices for mainframe computers, EMC viewed the addition of McData as a way to ease its entry into storage devices used in networked computer systems. According to Network World, "The bundling of the switch and storage products could give EMC a leg up against storage rivals and provide a boost for McData's technology." While the relationship with EMC did not prove as fruitful as anticipated, McData's founders and backers enjoyed a significant payoff for their investments in the garage startup.

Uncomfortable with being overly dependent on a single product sold to a single customer, McData entered the Fibre Channel switch market in 1997. As part of this change in direction, EMC restructured its ownership, resulting in a new McData Corporation with its own separate board of directors and the freedom to act independently of the parent company, although EMC remained the majority shareholder. The new McData's focus was on the development and marketing of products using Fibre Channel networking technology. The Escon Director business with IBM was packaged into a shell entity called McData Holdings Corp., which remained a wholly owned EMC subsidiary and through which EMC held a 90 percent stake in McData Corp. The major reason for the change in structure was that EMC had been holding back McData's growth and if the company was to realize its potential, and maximize its investment for EMC, it needed to be independent. "EMC is a very powerful, influential storage company," McData's Director of Communications Linda Reed told Computer Canada. "Other storage companies said that as long as we were a subsidiary of EMC, they weren't really interested in working with us." According to Rocky Mountain News, "the relationship with EMC was both a blessing and a curse. McData saw substantial revenue growth in those years as well as missed opportunities. The deal kept the company from selling to competitors and hampered its long-held desire to go public."

Company Perspectives:

McDATA products are designed to help you create a unified infrastructure—They bring together multi-vendor, multi-protocol, multi-location resources so that your data is available anytime, anywhere, across the global enterprise.

Break from EMC in 2001

Independent once more, McData could move beyond mainframes and bring fibre channel solutions to new markets while not jeopardizing its relationship with IBM. In short order it was able to develop end-to-end SAN solutions, teaming up with large corporations, such as Microsoft and Hewlett-Packard, which began incorporating McData's SAN solutions. The Chinese wall erected between McData Holdings and McData Corp. was eventually rendered moot. In 2000 the company reached an agreement with EMC that allowed it to make a public offering of stock and gave EMC shareholders one share of McData stock for every share they owned of EMC. In August 2000 McData completed a public offering of stock, raising $350 million, and in February 2001 EMC made the distribution of McData stock to its shareholders. As a result, McData was truly independent and EMC rivals could feel more comfortable doing business with it. As part of the arrangement, EMC also signed a two-year noncompete agreement.

Even before the break with EMC, McData began to diversify, imperative because of its agreement with EMC, as it looked ahead to the day when the noncompete agreement came to an end, knowing full well that there was no guarantee that EMC would continue to buy products and that it would be wise to line up new customers as soon as possible. In late 2000 McData launched a line of lower cost fibre switches, followed by the addition of software products offering clients what it called "Enterprise to Edge" data storage solutions. Several months later, in 2001, McData acquired SANavigator Inc., a San Jose developer of storage network management software.

McDonnell launched a succession plan in 2001, handpicking John A. Kelley, a former Qwest Communications vice-president, to serve as president and chief operating officer. A year later Kelley became chief executive officer, while McDonnell retained the chairmanship. Two years later, in January 2004, McDonnell gave up the chairmanship to Kelley, but six months later McDonnell was once again launching a storage-related startup, Crosswalk Inc. One of its first customers was McData, in which McDonnell continued to hold a significant stake.

As Kelley was assuming control, McData had to contend with difficult business conditions that resulted in disappointing earnings and led to a severe erosion in the price of its stock. McData performed better than most storage companies, enjoying solid growth in the mid-range market for its products. Wall Street, though, was not suitably impressed and failed to reward the company's stock, due in some measure to powerhouse Cisco Systems Inc. entering the market. In an effort to stay ahead of Cisco, as well as longtime rival Brocade Communications Systems, Inc., McData added new products by acquiring a pair of companies in 2003, paying $83 million for Sunnyvale, California-based Nishan Systems and $102 million for San Jose, California-based Sanera Systems. Through Nishan, McData gained software and hardware used to back up stored information in emergency or disaster situations. Sanera brought with it an advanced networking switch, linking computer servers and storage devices. At the same time, McData invested $6 million to buy a 15 percent stake in San Jose, California-based Aarohi Communications, developer of silicon solutions for intelligent storage networks. According to Computerworld, "Together, the three deals are designed to help McData broaden its existing line of directors for Fibre Channel storage-area networks (SAN) to include storage-over-IP capabilities. The technology additions will also expand the port count on the devices it sells from a maximum of 140 now to 256."

Conditions were still difficult in 2003 and 2004 for McData, which made significant job cuts to control costs. Not only did the company have to contend with lower sales, its competition cut prices. In addition Cisco became even more formidable by forging a partnership with EMC in early 2005. McData responded by acquiring Minneapolis-based Computer Network Technology Corporation (CNT) in a stock and debt deal valued around $235 million. The hope was that McData would become more competitive by adding CNT services and products related to wide-area network technology. Moreover, the deal strengthened its relationship with IBM, its second largest customer. IBM was CNT's largest customer. The acquisition was not well received by all parties, however, as reflected by an article in Boulder's Daily Camera that maintained, "Whether the purchase is enough for McData to hold its ground and grow remains to be seen. One analyst says the business—itself the subject of speculation as an acquisition target in recent months—was likely better off focusing on its own turnaround, rather than attempting to swallow another company working to reverse its fortune."