Aruba Networks Snaps Back to Reality

Jun. 3.11 | About: Aruba Networks, (ARUN)

In my fact finding mission to unravel the mysteries of telecom, I came across Aruba Networks (NASDAQ:ARUN) when it burst onto the scene by way of inclusion in the Investor's Business Daily top 50 stocks, commonly known to investors as the IBD 50. I think it's worth noting that equities on this list tend to be flavors of the month with sky high P/E ratios trading on fumes, but they can also be the stocks of our time with the technology, products and services that will lead us forward. If you are a short-term investor, this is a great list to cherry-pick holdings. If you are a long-term investor, it's a great list to watch for stocks to buy once they come back down to earth.

I believe that Aruba Networks is a speculative equity, but not a speculative company in that it will be in the conversation of wireless infrastructure leaders for the next decade. If you look for the company on the IBD 50, you won't find it there anymore. On 5/19/11 it reported better than expected numbers in its Q3 earnings call transcript, but tempered its outlook for Q4. Traders pinned their ears back and kicked the stock to the curb, putting a hitch in its giddy-up. The equity was up 57% in 2011, trading at about $32.50 before the announcement and when the dust had settled on the day after, it was down 17% to $27. At the time of this writing, it has rebounded slightly to $28.

According to a 5/20/11 article by J. Bonasia of Investor's Business Daily, Aruba Network Dives on Disappointing Outlook,"Aruba makes equipment for wireless local area networks. Such WLAN gear allows workers in remote offices securely connect tablets, smart phones and laptops to computer networks ... Aruba installs its security and management functions on mobile devices. The software then hooks into wired networks through an access switch. Ensuring the security of wireless devices is a growing priority for tech managers. Most mobile devices aren't issued by companies, but instead are acquired ad hoc by workers."

This phenomenon is what CEO Dominic Orr refers to as BYOD (Bring Your Own Device) in the Q2 earnings call transcript from the prior reporting period. In previous technology generations, it was the corporations that spurned technology growth. Now it is the consumer with the advent of Apple (NASDAQ:AAPL) and Google (NASDAQ:GOOG) based mobile devices. People own them, prefer them and want to use them for work. They're not waiting until next year for Microsoft (NASDAQ:MSFT)/Nokia (NYSE:NOK) products.

In the Q2 conference call, Mr. Orr addresses the explosive growth for his company and the industry it's in, and, cites not only the onslaught of smart phone and tablets in the workplace, causing demand for Aruba's products, but: "... the sharp increase in demand for multimedia-rich mobility applications, particularly video, has set a new bar for user expectation and a network that must not only connect but deliver the experiences and user demand ... the rise of both server and desktop virtualization has quickly increased the business relevance of the incoming wave of new mobile devices and tablets. And most of all, it's about providing a comprehensive security implementation to ensure the accelerated path to mobility is a safe one."

To paint a picture on just how fast Aruba Networks grew this past year, we just have to look at its recent earnings history. According to Yahoo Finance, trailing 12 months earnings per share is three cents with a P/E Ratio of 1,000 for the same time period. Consensus earnings estimates for 2011 is $0.59/share with a P/E Ratio of only 47. The problem arises when we look out to 2012 and see that earnings are supposed to grow only 10% with an EPS of $0.65. Things are decelerating, but perhaps the analysts are low balling their projections. I tend to think earnings will be better than the 10% estimated, just by the nature of the industry they're in - Wireless Local Area Networks.

In previous posts I've discussed my belief that we are in the beginning stages of a new technology era. This includes local area networks that have traditionally been wired but are increasingly becoming wireless. John Henry built the transcontinental railroad with his sledgehammer, but the steam-drill made him expendable. Hence the proliferation of WLAN in the enterprise and the growth of companies like Aruba Networks. In fact, the sector is dominated by just two companies; Cisco Systems (NASDAQ:CSCO) by a wide margin and Aruba at a distant second place.

In a press release from Aruba on 5/24/11, Aruba Networks Makes Great Strides in Wireless LAN Market Share: "Aruba networks today announced that its market share in the Enterprise WLAN space had sequentially increased to 15.9% according to a research report by Dell'Oro Research on Friday, May 20th. This result marks an acceleration of Aruba's market share gains, primarily at the expense of Cisco ... Illustrating the healthy WLAN growth, as well as Aruba's strong competitive posture, the market grew 22% from CYQ1 2010 to CYQ1 2011, while Aruba's revenue grew 52.5% that same period."

Going back to the J. Bonasia article in Investor's Business Daily, "Another source of growth for Aruba involves the move from an older wireless networking standard called 11g WiFi to a faster standard, 11n." That's a boost for Cisco's sales, too, and we can surmise that there is a little game going on between the two companies. But Aruba may have just played a trump card with its recent introduction of MOVE (mobile virtual enterprise) architecture, at least in the short term.

CEO Orr addresses this technology in the most recent conference call: "Aruba MOVE integrates wireless, wired and remote silos into one cohesive access solution that enables by cloud-based mobility services. Access privileges are context aware, meaning that they are based on user, device, application and location, and this dictates the type of network resources each person is entitles to access." The company feels this could be a boon for business in that it improves productivity and reduces costs for their customers.

Cisco recently decreased its guidance because of a pullback in government spending. I'm not sure what kind of an impact that will have on Aruba Networks going forward because they do have exposure to some government entities like the FDIC and the United States Air Force. It is my belief that this equity will remain shell-shocked in no man's land, trading in-sync with the overall market until next quarter when we can get a better look in the uptake of the MOVE architecture. I like these technology pure-plays like Aruba much more than I like industry behemoths like Cisco.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Additional disclosure: I'm short the indexes with leveraged ETFs.