Arista Networks – A Compelling Long-Term Investment

Arista Networks – A Compelling Long-Term Investment

SUMMARY

  1. Arista Networks is a distruptive cloud-based networking company that is gaining market share from incumbents.
  2. With a product leadership economic moat, it is poised to continue its ascend while fighting off competition.
  3. A strong leadership at the helm is a huge plus for this company.
  4. Investors have a chance to participate in its growth and reap huge returns in the process.

 

  1. Introduction

Tech companies these days have earned the reputation of being ridiculously overpriced. Frankly, it is getting more difficult by the day to spot bargains in the market because the DOW 30 index or the S&P 500 index make new highs almost every other day. What is an investor to do?

For every incumbent in the market, there is bound to be a disruptor and this cannot be more true for companies that operate in the technology industry. And today, we will take a look at a company that has been causing much disruption in the networking technology space.

Arista Networks (NYSE: ANET), founded in 2004 by Andy Bechtolsheim his co-founder David Cheriton, is a computer networking company that designs and sells multilayer network swhttp://bit.ly/2Adb8E4itches to deliver software-dfined networking. For readers who are less technical, Arista’s open-source networking technology helps companies move vast quantities of data over the Internet a blazing speeds. When computers transmit data all over the world, there were initially two fundamental questions to address. Firstly, how much of data can be transmitted and secondly, how quickly. As technology involves, a third question arose: how safely can data be transmitted? The management team at Arista Networks work around the clock to ensure that it is able to provide a top-notch service for all of its customers and in doing so, ensures that investors are generously rewarded.

  1. The Business

The business has been firing on all cylinders over the past year. As more companies move away from traditional hardware-based systems, Arista Network stands to take advantage of the deal flow that comes its way. As the demand for the company’s software-driven cloud networking solutions for large data center storage and computing environments, Arista was able to clinch contracts from some of the most impressive names in tech which includes Facebook, Amazon.com and Google.

Source: Author

A high-octane roster of clients comes along with very combustible growth. The company was able to achieve more than $1 billion in revenue in 2016 which is thrice as high as the revenue geenrated in 2013. Operating cash flow from 2013 to 2016 skyrocketed four-fold from $35 million to $131 million and free cash flow has increased tremendously over the same time period. The company has also improved its return on invested capital from 62% to almost 88% over the same period. With cash soaring eight-fold from $114 million in 2013 to $823 million in the latest quarter and no debt on the balance sheet, Arista Networks looks to be a very solid investment opportunity at the moment.

Source: Author

 

Another boon to the business is also the expanding margins it has enjoyed. While gross margin remained the same at 66% throughout the years, the company’s operating margin and free cash flow margin has increased from 18.31% to 21.56% and 3.97% to 9.74% respectively. The company has also been extremely disciplined in making sure that they deliver the best products to their customers and have shown this by reinvesting almost a quarter of their revenue into research and development. Such investments would help the business remain competitve and enable it to launch new products and systems.

 

  1. Management

Bechtolsheim co-founded HighBAR Ventures, an early-stage venture capital investment with the aim of funding revolutionary ideas. With the background of an electrical engineer, Bechtolsheim has pioneered and funded many smaller tech companies back in the 1990s.

In September 1998, Bechtolsheim and Cheriton provided Larry Page and Sergey Brin their first round of venture capital funding as each invested $100,000 into a little start-up company called Google. Many investors should feel at ease now knowing that the funder of Google actually works for them if they were to invest in Arista Networks!

From 1996 to 2003, Bechtolsheim and Cheriton took up leading positions in Cisco Systems, a larger rival that they will soon compete against once they found Arista Networks in 2004. In May 2008, Jayshree Ullal left Cisco Systems after more than a decade in the company and was appointed as the CEO in Arista in October 2008.

Lastly, Bechtolsheim and Ullal currently owns approximately 25% of the company’s share. With that much equity stake in the game, investors can be assured that their interests are aligned with shareholders’.

  1. Risk

There are many players that are in the computer networking space. Smaller players include Brocade Communications Systems and Juniper Networks. However, the giant that Arista must face is Cisco Systems. Valued at more than $150 billion at the moment, it is more than ten-times the size of Arista. And while it is being disrupted, investors cannot ignore the potential risks that may arise along the way.

In 2014, Cisco filed a lawsuit accusing Arista of copyright and patent infringement. While the court case tied Arista in court, management was able to maintain their composure in the face of adversity. It is likely that the company will follow through on compliance matters and the incident will blow over.

While there may be alternatives to Arista’s products and services in the market, the management has been investing heavily to ensure they are the lead-husky. If there are significant setbacks in the systems that would put a dent on customer retention, the risk level of this investment would increase substantially. After all, the reason why Arista has flourished was because of its superior product offerings.

Lastly, investors would not want to see the current management team leave. A business lives and dies by the people who steward them so investors should keep an eye on the transition should such a scenario play out.

  1. Conclusion

Arista Networks has thrived in this cut-throat industry because it has an outstanding leadership team that knows how to steward the business with the objective of serving its stakeholders well. The short-term price of the company has rose rapidly and investors might have second thoughts about committing capital at this point in time. However, one should never be intimidated by the ascension of the stock price. This is a company with an accelerating sales growth, growing market share and rock-solid financials. It has displayed signs that it will continue its upward trajectory for years to come and now would be a good time to get onboard.

If you want to learn more about how to find cheap and good stocks to generate passive income for you, click on the picture below to join our Free Value Investing Masterclass.

Marcus Ho
Research Analyst, Mind Kinesis Value Investing Academy

Disclaimer: Please note that all information stated in this article is just for education purpose only and should not be used as any form of recommendation or advice.

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