- ANET went public on Friday and despite the warm reception, may actually be cheap. The company has been profitable for 4 years with average annual growth of 71%.
- Cloud computing is the fastest growing segment of the tech universe and Arista has the switches to meet the demand.
- The software allows for seamless integration for other software providers and constant monitoring of each individual switch.
Arista Networks (NYSE:ANET), a maker of high-speed switches for big data, went public last Friday and although the stock priced above the range and closed up 27% on the first day of trading, I actually thought the stock would open much higher. Arista could be the best small technology company to go public in many years in my opinion and I came up with a list of 10 reasons why.
#1 Unlike almost all the hot IPOs over the last two years, Arista is not only profitable now but has been profitable since 2010. The company also has not only been growing quickly at an average annual pace of 71% since 2010, but this growth is actually accelerating. Revenue growth in 2013 was 83% over 2012 and in the first quarter of this year (2014) was 91%. This was all done while Cisco (NASDAQ:CSCO) spent much time and effort on its own "Arista killer", called the Nexus 9000, but so far it has not made a dent in Arista's growth.
#2 What is helping Arista is the migration to the cloud on the corporate, government, education and consumer levels. Cloud computing needs seamless instant integration of thousands of servers which can only be done with high-speed switches with low power consumption and virtually no latency, similar to technology that Arista provides. According to Crehan Research (from the company's S-1), the demand of high-speed data switches will double from $6 billion last year to $12 billion in just four years time. The data center switching market will grow to $16 billion.(here)
#3 Also, according to Crehan research, Arista has only a 6% share of the market to Cisco's 71%. If Arista can double its share in the next four years in a market that will double, the company's revenue can grow four-fold over that time span.
#4 Arista has several advantages over Cisco that has enabled the company to gain a foothold in the space. The first is its software platform called EOS. EOS enables companies to rapidly deploy new features as they become available. At the same time it allows the monitoring, handling repair and patching of each switch individually if needed, which reduces latency and downtime in the case of failure. The openness of the software also allows the network software to be tailored specifically to each customer's needs.
#5 The open system of EOS allows for partnerships with the biggest names in cloud software and management. VMware (NYSE:VMW), Splunk (NASDAQ:SPLK), Palo Alto (NYSE:PANW), Microsoft (NASDAQ:MSFT), Aruba (NASDAQ:ARUN), F5 (NASDAQ:FFIV) SAP (NYSE:SAP) and others are all strategic partners. You can see the full list on the company's website. (here)
#6 Speaking of Microsoft, it has become Arista's biggest customer as it builds its own cloud network. New CEO Satya Nadella has made the company's migration to the cloud his No. 1 priority which should mean a lot of revenue for Arista.
#7 Without getting too technical, Arista's switches are very scalable and modular and they are set up in a way that makes it easier for companies to use them efficiently. It was the first company to enable a two-layer network - called a leaf spine network - it is very efficient with all nodes equidistant and no stranded ports. This has since been copied by Cisco. Several months ago, the company went a step further and launched what is called a "spline" network. This network allows up to 2,000 servers to be directly connected via one tier. What this does is virtually eliminate latency in the network. This new "spline" system could give the company a new leg up on Cisco and push the company to gain share above and beyond what it has already taken from the market leader.
#8 The management team is excellent with the co-founder and Chairman Andreas Bechtolsheim being one of the founders of Sun Microsystems and was among the first investors in Google. CEO Jayshree Ullal was the VP of data center switching at Cisco. Both the VP of engineering and VP of manufacturing were also top execs at Cisco which were lured away. I have heard that Arista is one of the favorite companies for engineers to work in Silicon Valley, as it is an engineering company at its core and the majority of its employees are engineers.
(As an aside the other co-founder David Cheriton is the biggest shareholder, but is actually suing his own company because he feels another company he owns which was a sister company to Arista did not get its share of an agreement to share improvement in each other's software. Arista is countersuing. This is most likely going to be settled before it goes to court in the summer. However, even if somehow Arista loses the suit, it poses no threat to the company itself. The lawsuit does not involve the company's core technology.)
#8.5 There is not one dollar of VC money invested in Arista. All the non-IPO shares are owned by the founders or employees and that means they are invested in making the company and its stock grow.
#9 Post IPO, the company now has more than $300 million in cash and no debt. Since it is profitable, the company will actually be growing its war chest, which could be used to make small acquisitions or be spent on R&D.
#10 The company may actually be cheap on a PEG (price/earnings to growth) basis. Arista earned $.77 last year and could earn around $1.40-$1.50 this year (non GAAP), even if revenue growth slows back to 80% from the 90% in the first quarter. At $1.40 in earnings, the company is selling for under 40X earnings at a growth rate double that, giving it a PEG of 0.5. You will be hard pressed to find any company growing at this rate with a PEG of under 1, much less half the growth rate. Say Arista grows EPS only 50% in 2015, we can get to $2.10-$2.25 which gives it a P/E of only in the 20s on 2015 numbers.
My guess is if Arista can get to over $1.40 in earnings with a good outlook for next year, the stock can easily hit $100 by year's end.