Arista Networks (ANET): will the unstoppable growth continue?

0
237

Arista Networks (ANET): will the unstoppable growth continue?
October 13th, 2017

Arista Networks (ANET) represents everything The Ridge is all about: big market and technology disruptions, a small start-up with the right products at the right time, exponential sales and earnings growth, taking personal and financial risks, incumbent corporations too big and too slow to address the new challenges, fortunes being made by investing at the right time, etc.

Arista was founded in 2004 by two former Cisco executives, Andy Bechtolsheim and David Cheriton. Prior to Arista they co-founded Granite Systems, a company developing gigabit Ethernet products which was acquired by Cisco Systems in 1996. The small start-up Arista found some initial success developing a fast networking switch for Wall Street trading networks. A small market indeed but big enough to give Arista a foothold. In 2008 Arista hired Jayshree Ullal, another former Cisco executive, to become its CEO.

The global market for network switches and routers was totally dominated by Cisco Systems, a giant that at some point during the past decade had become the most valuable company in the world. Led by John Chambers, currently Cisco’s executive chairman, Cisco grew exponentially during the 1990s by acquiring competitors including Granite Systems as mentioned and Crescendo Communications where Ms.Ullal worked as VP of Marketing. By the middle 2000s however Cisco started to show some of the symptoms afflicting big organizations: slower decision making, too much bureaucracy, rigid rules, etc just at a time when the market was starting to shift from a vertical point-to-point networking paradigm to cloud computing and distributed applications. Internal frustration within Cisco led to the departure of some key personnel including Ms.Ullal.

Arista developed a line of products precisely to address the changing market needs and started getting business from several key Cisco customers including Microsoft and Facebook. The growth in sales has been exponential since then. Cisco has tried everything in the books to stop the bleeding, including several ongoing lawsuits, but with no success so far. For a very interesting description of the personal feud between Mr.Chambers and Ms.Ullal see article by Rachael King at Fox Business.

The chart below, assembled with data from IDC, shows the composition of the global Ethernet switch market as of Q2 2017 and compared to same period a year ago. Cisco is still the market leader with over 54% market share and $3.5B in quarterly sales. It is followed far behind by Huawei, Hewlett Packard, Arista and Juniper Networks. Cisco’s market share however is being constantly eroded by growing sales by mostly Huawei and Arista. What separates Arista from the rest is the breathtaking growth in sales: over 50% sales growth over same period last year. This is also reflected in the increase in market share from 3.9% to 5.5%.

Worldwide Ethernet switch market Q2 2017 (Source: IDC)
Cisco

Huawei

HPE

Arista

Juniper

Q2 2016 Mkt. Share 56.8% 6.5% 6.0% 3.9% 3.5%
Q2 2017 Mkt. Share 54.7% 8.5% 5.6% 5.5% 4.3%
Q2 2017 Sales

$3.5B

$546M

$360M

$353M

$276M

This phenomenal growth in sales was followed with equally amazing earnings growth. It is not surprising then the incredible run in Arista’s share price this year as shown in the chart below.

finviz dynamic chart for  ANET

Let’s take a look at valuation.
Share price today is $191.21 and P/E ratio is at 49.79 using EPS ttm (trailing twelve months) of 3.84 (source finviz). It is not a cheap stock and obviously investors are factoring the positive growth story described in the share price. Forward average EPS estimates for FY17 (4.7)  and FY18 (5.62) give P/E ratios of 40.68 and 34.02 respectively. Now these EPS estimates may be on the conservative side if Arista delivers in 2018 a performance similar to that in 2017. Using slightly higher EPS estimates and a P/E of 30 The Ridge estimates a target price range between $195 and $225 by the end of 2018.
Our view is that ANET is a stock to own for the long term. Some estimates put Arista market share at 19% by 2020 which if delivered will provide for double digit CAGR for years to come. Arista’s financial health is also worth mentioning: no debt and positive operating cash flow. Institutional ownership of over 60% is also a plus.

Arista Networks will announce financial results for Q3/2017 on November 2nd.

Neither The Ridge nor any of its employees owns ANET or any stocks mentioned in the article as of today. Please see disclaimers here.