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Shares of Aruba Networks (NASDAQ:ARUN) took a plunge in Tuesday's trading session, falling almost 23% after the provider of next-generation network solutions announced its preliminary third quarter results before the market open.

The sell-off is justified as the poor revenue guidance is accompanied by an even worse earnings guidance.

Preliminary Third Quarter Results

Aruba Networks expects to generate preliminary third quarter revenues of $144 to $147 million, below the previously guided $159 to $161 million. Consensus estimates for the quarter stood at $160.6 million.

Non-GAAP earnings are expected to come in between $0.11 and $0.12 per share, compared to a previous guidance of $0.20 per share and similar consensus estimates. The company expects to report GAAP net losses between $0.18 and $0.20 per share.

The profit warning is coming a bit late, Aruba is scheduled to report its full results on Thursday, May the 6h.

The guidance implies that revenues are expected to increase between 9.2% and 11.4% on the year before which is soft given that revenues for the first six months were up more than 22% on the year.

CEO Dominic Orr commented on the disappointing developments, "In April, we saw a push out in customer orders across the Americas, Europe and Asia. We attribute this weakness primarily to a challenging economic environment worldwide. While we are disappointing with our results, we remain confident in the strength of our differentiated application-aware MOV architecture and the value proposition we bring to the marketplace."

Valuation

Aruba Networks ended its second quarter of its fiscal 2013 with $402.3 million in cash, equivalents and short term investments. The firm operates without the assumption of debt, for a solid net cash position.

Revenues for the first six months of 2013 came in at $299.8 million, up 22.1% on the year before. The company reported a $4.2 million profit, compared to a loss of $11.8 million in the comparable period the year before.

At this rate the company is on track to generate annual revenues of around $600 million on which the firm could roughly break-even or report a modest loss.

Factoring in a 23% decline in Tuesday's trading session, the market values Aruba around $1.95 billion. This values operating assets of the firm around $1.45 billion which implies a valuation of 2.4 times annual revenues.

Aruba Networks does not pay a dividend at the moment.

Some Historical Perspective

Shares of Aruba have seen a decent run up after hitting lows of $2 during the financial crisis in 2008 and 2009 before a long term recovery send shares to highs around $35 in 2011.

Shares have seen a decent correction to $15 halfway through 2012 but have recovered to levels around $25 this spring. Shares have lost a third of their value ever since, currently exchanging hands at $17 per share.

Aruba has been rapidly growing its operations in recent years. Between its fiscal 2009 and 2012 the firm has grown its revenues by a cumulative 160% to $516.8 million. Despite the rapidly increasing revenues the company has reported operating losses over the past years.

Investment Thesis

Investors are severely disappointed with Aruba's latest warning. After reporting years of strong revenue growth the firm finally began to report operating earnings in the first half of 2013.

The latest warnings guides for a severe slowdown in revenue growth, and worse the firm expects to report a hefty $0.20 per share loss, of almost $25 million.

While the external environment is to blame, as customers delay their orders, the firm is facing competitive issues as well. Telecommunication providers are cutting back on capital expenditures, but customers were holding off on orders in Europe and Asia as well.

Aruba can easily manage these losses given the significant net cash position of the firm and the fact that the company operates without debt. Still, the expected losses are really disappointing amidst this bad revenue miss. Note that net earnings almost missed by the same dollar amount as revenues, indicating severe trouble.

Back in August of last year I took a look at the prospects for Aruba Networks. At the time shares rose 15% after reporting a strong set of fourth quarter earnings results and a $100 million share repurchase program. At the time shares were exchanging hands around $17 per share but I concluded to remain on the sidelines.

I cited the lack of structural profitability, limiting the upside in my mind. Yet shares rallied almost 40% from that point in time to highs of $25 earlier this year. The latest sell-off has wiped out all returns since August, resulting in a severe underperformance versus the wider equity markets.

Today I reiterate my stance. I won't initiate a long position given the lack of structural profitability, while a potential of a take-out makes the short side not attractive either.

Source: Aruba Networks - Shares Sell Off After A Bad Revenue Miss And An Even Worse Earnings Miss