Arista Networks, Inc. ($ANET)
Arista Networks, Inc. ($ANET)
"A leader in AI-driven networking solutions, poised for robust growth with strong financials and strategic innovations in a competitive market."
This write up was done in collaboration with Iskan Rakhmatov from
.100% of the research was done by Constellation Stocks, I just added couple of final touches.
If you would like to learn more about Iskan, check out his Twitter / X & his Substack.
Disclaimer is at the end.
Highlights
Market Position and Competition: Arista Networks holds a strong market position with an 11.1% market share in the Ethernet switch market, demonstrating significant growth, particularly in the data center segment with a 35.2% increase in revenues for 2023. The company competes in a vibrant and highly competitive sector dominated by major players like Cisco, challenging Arista to continually innovate and expand its product offerings.
Financial Performance: For Q1 2024, Arista Networks posted revenue of $1.571 billion, a 16.3% increase year-over-year, driven by robust demand across all business segments. The company reported a net income of $637.7 million, significantly up from the previous year, reflecting strong operational efficiencies and revenue performance.
Management Guidance for 2024: Arista forecasts Q2 2024 revenues to be between $1.62 billion and $1.65 billion, projecting continued growth driven by demand in cloud and AI networking. Management remains focused on maintaining a strong non-GAAP gross margin of around 64% and an operating margin of approximately 44%.
Challenges and Opportunities: Arista faces challenges such as supply chain disruptions and intense market competition which could impact pricing and profit margins. However, opportunities exist in expanding its innovative cloud networking solutions and AI capabilities, which could drive future growth and market share gains.
Strategic Developments: The company is actively investing in R&D and market expansion initiatives, particularly in AI and cloud networking, which are expected to support long-term growth. Additionally, Arista's $1.2 billion stock repurchase program, running from 2024 to 2027, demonstrates confidence in its financial health and long-term strategy.
Price Action: Over the past year, Arista Networks' stock price has significantly outperformed the S&P 500, reflecting the market's positive reception to the company's robust financial results and strategic positioning.
Company Description
Arista Networks, Inc. was incorporated in 2004 and is headquartered in Santa Clara, California. The company engages in the development, marketing, and sale of data-driven, client-to-cloud networking solutions for data center, campus, and routing environments in the Americas, Europe, the Middle East, Africa, and the Asia-Pacific.
The current portfolio of offerings from Arista Networks is categorized into the following three product categories:
Core: high-speed Data Center and Cloud Networking systems, including newer artificial intelligence ("AI") Ethernet switching platforms.
Network Software and Services: a suite of value-add software solutions that leverage Arista’s EOS to provide advanced end-to-end orchestration, automation, analytics, network monitoring, and security.
Cognitive Adjacencies: campus wired and wireless products and advanced routing systems addressing Core Routing, Edge Routing, Data Center Interconnect (DCI), Multi-cloud, and Wide Area Networking (WAN) use cases.
Since beginning to ship products in 2008, Arista Networks has experienced rapid growth. According to market research in 2023, the company has achieved the leadership position in high-speed Ethernet port shipments of 100G and above and the second largest market share in overall data center Ethernet switch ports and revenue.
Arista Networks serves customers across a diverse range of industries and geographies, including large cloud customers or hyperscalers, other internet providers, service providers, financial services organizations, government agencies, and a cross-section of enterprise customers. Over the past five years, the company has diversified the types of enterprise customers it sells to and has continued to expand its presence across a wide spectrum of industries, including media and entertainment, healthcare, oil and gas, education, manufacturing, industrial, and more. Meta Platforms and Microsoft, two of Arista Networks' cloud end customers, each accounted for more than 10% of the company's total revenue for the years ended December 31, 2023, and December 31, 2022. It markets and sells its products through distributors, system integrators, value-added resellers, and original equipment manufacturer partners, as well as through its direct sales force.
The company went public in June 2014 and currently has more than 8,000+ cloud customers worldwide. Arista Networks has been profitable and cash flow positive since 2010.
Market Position and Competition
Ethernet Switch Market
The worldwide Ethernet switch revenues grew 20.1% y/y in 2023 to $44.2 billion. The total worldwide enterprise and service provider (SP) router market recorded $16.4 billion in revenue in 2023, a y/y decline of 0.4%.
There were varying trends across the datacenter and non-datacenter portions of the Ethernet switch market. Revenues in the data center (DC) portion of the market rose 13.6% y/y in 2023. Datacenter Ethernet switching made up 41.5% of the total market’s revenues, with the remaining in the non-datacenter portion.
Revenues for 200/400 GbE switches rose 68.9% for the full year in 2023 in the data center segment. 100GbE switches, which make up 46.3% of the data center segment's market revenues, rose 6.4% for the full year. ODM (original device manufacturer) Direct sales continue to be an important part of the data center segment, rising 16.2% y/y in 2023 to make up 14.3% of the data center segment's revenues for the full year.
The non-datacenter (non-DC) segment of the Ethernet switch market grew 25.2% y/y in 2023. With improved component availability, vendors are increasingly able to recognize revenues from fulfilling backlogged product orders, leading to high growth rates.
The non-DC segment, which includes lower-speed switches that are typically deployed in enterprise campus and branch locations, saw mixed results by speed. 1GbE, which made up 56.5% of the segment's revenues in 2023, rose 24.2% for the full year. 10GbE switches, which made up 20.4% of the non-DC segment's revenues in 4Q23, rose 5.3% for the full year.
From a geographic perspective, the total Ethernet switch market in the United States saw growth of 28.8% for the full year 2023. In Western Europe, the market rose 19.3% for the full year. In Central & Eastern Europe, the market grew 20.7% for the year. In China, the market was down 4.0% for the full year 2023. Across the broader Asia/Pacific region (excluding Japan and China), markets grew 15.0% in 2023.
The worldwide Ethernet switch market was dynamic in 2023, driven by a variety of trends, in particular by the impact of AI. In the data center portion of the market, enterprises and service providers are building ever-faster Ethernet switch speeds to support rapidly maturing AI workloads. In the non-datacenter portion, Ethernet switch vendors are embedding AI capabilities in software management platforms to improve operations. Connectivity in general, and Ethernet switching in particular, are playing an increasingly critical role in supporting the era of AI everywhere.
Arista market TAM
Arista's management estimates that by 2027, its total addressable market (TAM) could grow to $60 billion.
Competition
The markets in which the company competes are highly competitive and characterized by rapidly changing technology, changing end-customer needs, evolving industry standards, frequent introductions of new products and services, and industry consolidation. The company expects competition to intensify in the future as the market for cloud and AI networking expands and existing competitors and new market entrants introduce new products or enhance existing products. The data center and campus networking markets have historically been dominated by Cisco, with competition also coming from other large network equipment and system vendors, including Nvidia, Extreme Networks, Dell/EMC, Hewlett Packard Enterprise, and Juniper Networks.
Most of the company's competitors and some strategic alliance partners have made acquisitions and/or have entered into extended partnerships or other strategic relationships to offer more comprehensive product lines, including cloud networking solutions. For example, Broadcom has acquired VMWare and Hewlett Packard Enterprises has entered into an agreement to acquire Juniper Networks.
Top Ethernet switch vendors:
Cisco's Ethernet switch revenues increased 22.2% y/y in 2023. Non-DC revenues made up 69.5% of Cisco's total Ethernet switch revenues in 2023 and rose 28.6% y/y for the full year. DC revenues made up the balance and rose 9.7% for the year. Cisco's total Ethernet switch share stood at 43.7% for the full year 2023. Cisco's combined service provider and enterprise router revenue rose 1.4% for the full year 2023, giving the company a market share of 35.7% for 2023.
Arista Networks Ethernet switch revenues – 91.4% of which are in the DC segment – increased 35.2% in 2023, giving the company an 11.1% market share for the full year 2023.
Huawei's total Ethernet switch revenue increased by 10.6% in 2023 and 16.5% in 4Q23, giving the company a market share of 9.4% for the full year 2023. The company's combined SP and enterprise router revenue rose 2.6% in 2023 and was up 0.9% in 4Q23, giving the company a 29.2% market share for 2023.
Financial Performance of Q1 2024
Revenue: For 1Q 2024, Arista Networks posted a revenue of $1.571 billion, marking a sequential increase of 2.0% from 4Q 2023 and a significant 16.3% y/y growth from 1Q 2023. This growth is attributed to sustained demand across all business segments (especially in the Enterprise segment), particularly driven by increased adoption of data-driven networking solutions and expansions in AI and cloud infrastructure.
Gross Margin: GAAP gross margin was reported at 63.7%, a decrease from 64.9% in 4Q 2023 but an improvement from 59.5% in 1Q 2023. The y/y margin improvement is mainly due to better supply chain efficiency and a favorable product mix.
Operating Expenses: There was a slight increase in operating expenses due to strategic investments in R&D and market expansion, aligning with the company’s growth trajectories and innovation focus.
Net Income: Reached $637.7 million, translating to $1.99 per diluted share, significantly up from $436.5 million (Non-GAAP $452.5) or $1.38 (Non-GAAP $1.43) per diluted share in 1Q 2023. The increase in net income reflects strong revenue performance and operational efficiencies.
Management Guidance
Revenue: For Q2 2024, Arista Networks projects revenue in the range of $1.62 billion to $1.65 billion. This guidance reflects a steady demand across their key sectors, driven by continued expansion and innovation in cloud and AI networking. The projected revenue marks a sequential increase from Q1 2024, where they reported $1.571 billion, which itself was a significant y/y growth of 16.3% from Q1 2023.
Gross Margin: The company expects a non-GAAP gross margin of around 64% for 2Q24, slightly down from 64.2% in 1Q24. The slight decrease is attributed to various factors including product mix and possibly some incremental costs associated with new product ramps or changes in component costs.
Operating Margin: For non-GAAP operating margin, Arista anticipates around 44%. This forecast is consistent with their strategic focus on maintaining profitability while investing in growth opportunities, particularly in the AI and cloud networking sectors.
Stock Repurchase Program: Reflecting a strong balance sheet and confidence in long-term business fundamentals, in May 2024, Arista’s Board of Directors authorized a new $1.2 billion stock repurchase program, which commences in May 2024 and expires in May 2027. The timing and exact amount of repurchases will be based on market conditions and other factors such as capital needs and acquisition opportunities.
Strategic Outlook: The management's commentary suggests a robust outlook for Arista, supported by strong demand in their core markets of large data centers, AI, and cloud networking. The ongoing development of innovative products and the expansion of service offerings like the Universal Network Observability further underscore their strategic direction. Arista’s management is focused on leveraging its strong market position to deliver sustained growth and shareholder value over the long term.
Challenges and Opportunities
Headwinds and Risks
Supply Chain and Component Availability: Arista Networks faces ongoing challenges in maintaining a smooth supply chain. Delays in component availability can hinder production schedules, impacting the company's ability to meet client demand promptly. As the technology sector continues to rebound from global disruptions, these issues remain a significant risk.
Regulatory and Compliance Pressures: Increasing global regulatory scrutiny, especially in data security and privacy, poses a risk. Compliance with these evolving standards requires constant adaptation of technology and practices, which could lead to increased operational costs.
Market Competition and Pricing Pressures: The competitive landscape in cloud networking is intense, with major players continuously innovating. Arista needs to keep its offerings competitively priced without compromising on profit margins, a delicate balance in a price-sensitive market.
Tailwinds
Innovation and Market Expansion: The introduction of CloudVisionⓇ Universal Network Observability™ (CV UNO™) and advancements in AI-driven networking solutions present significant growth opportunities. These innovations enable Arista to tap into emerging market segments and expand its customer base across data centers, campus, and wide area networks.
Strategic Acquisitions and Alliances: Arista’s strategic focus on acquisitions and alliances can bolster its market position. These ventures not only enhance product offerings but also expand its geographic and sectoral footprint, which is crucial for long-term growth.
Financial Strength and Stock Repurchase Programs: The company’s robust financial position, highlighted by significant increases in revenue and net income y/y, supports strategic initiatives like the newly authorized $1.2 bln stock repurchase program. Such financial maneuvers not only affirm Arista’s market confidence but also enhance shareholder value.
Valuation Considerations
Share price performance
Over the past 12 months, the company's price has significantly outperformed the S&P500.
Stock Price Target Estimate
Our goal is to estimate the share price by the end of the year. We achieve this by analyzing the company's historical P/E and P/S multiples, selecting the level most appropriate for the macroeconomic and company-specific factors expected within the year, and incorporating consensus forecasts for Revenue and EPS. This methodology allows us to make stock price estimates in a way that is both quick and precise, which is suitable for our investment horizon.
Considering the historical P/E pattern for ANET, we view a 40x multiple as the “normal” level achievable by the company in the current economic and financial environment.
Based on the expected non-GAAP EPS for 2024, we calculate a target price of $320.1. This represents the current stock price levels. and we wouldn’t be surprised by potential upward revision estimates going higher for all potential AI beneficiaries after NVIDIA’s recently released strong earnings report.
Industry Comps Breakdown
For the comparable multiples analysis, we consider the following companies as ANET's closest peers. Cisco Systems Inc. (CSCO), Juniper Networks, Inc. (JNPR), and NetApp, Inc. (NTAP) are prominent players in the networking business, offering comprehensive solutions across routers, switches, and cybersecurity (Cisco and Juniper), as well as data storage and management (NetApp). Meanwhile, Dell Technologies Inc. (DELL) and Hewlett Packard Enterprise Co. (HPE) focus on delivering a wide range of computing and digital technology solutions, including servers and data storage, tailored for businesses and individual consumers.
Arista's multipliers are significantly higher than those of its competitors, due to higher revenue and profit growth rates.
Sales Estimates Revision
Earnings Estimates Revision
Estimates tend to improve markedly after almost every quarterly result.
Conclusion
In conclusion, Arista Networks stands as a formidable force in the data-driven networking arena, skillfully navigating the competitive and rapidly evolving tech landscape. With a robust 16.3% year-over-year increase in revenue, reaching $1.571 billion in Q1 2024, and strategic expansions in AI and cloud networking, Arista is well-poised for sustained growth. The company's proactive investments in innovation and market expansion, coupled with its strategic stock repurchase program valued at $1.2 billion, not only underscore its financial robustness but also its commitment to delivering shareholder value. As the AI-driven market continues to flourish, Arista's forward-looking initiatives and adaptable business strategies suggest a bright future, making it an attractive prospect for informed investors seeking exposure to high-growth networking solutions.
Holdings Disclosure
At the time of this publication, Iskan Rakhmatov and I (YZ) don’t own any shares of ANET 0.00%↑.
P.S. Don’t forget to ❤️ if you enjoyed it.
Disclaimer
The information in this article is provided for informational and educational purposes only.
The information is not intended to be and does not constitute financial advice or any other advice, is general in nature, and is not specific to you. Before using this article’s information to make an investment decision, you should seek the advice of a qualified and registered securities professional and undertake your own due diligence.
None of the information in this article is intended as investment advice, as an offer or solicitation of an offer to buy or sell, or as a recommendation, endorsement, or sponsorship of any security, company, or fund. The author is not responsible for any investment decision made by you. You are responsible for your own investment research and investment decisions.
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Very under covered company, rarely see it mentioned. Had no idea that it outperformed the S&P 500 that much during the past year. Thanks!
Great and comprehensive writeup on Arista! I am a happy Arista shareholders since 5 years. But be aware of the valuation, Arista stock is quite expensive after the enormous rallye. Why I don't think now is the perfect entry point? https://hightechinvesting.substack.com/p/arista-networks-share-a-twenty-bagger