Context and history
Arista Networks (ANET) was founded in 2004 by three hardware entrepreneurs. The company decided to challenge the existing technological infrastructure with hybrid networking products. At its core, Arista Networks is a provider of data center equipment with a variety of SaaS verticals. The company hosts virtual machines that power the cloud, high-performance computing, and even high-frequency trading terminals.
The hybrid networking of Arista’s suite of technology offerings has created immense value over the past year. The stock is up nearly 75% in 2021 and looks to extend its gains until early this year. Also being a hardware game, Arista was kept afloat as many pure SaaS names were dropping big double-digit numbers. With the continued expansion of the company’s virtual offerings as well as the growing demand for data center equipment, Arista networks offer great growth in their industry segment.
High demand for data centers
The demand for data centers has been strong throughout 2021. I wish this trend would improve further due to the growing reliance on technology. This is true of the consumer at the corporate level. Our lives are steeped in technology, and businesses need businesses to help break down data silos and streamline networking operations. By offering hybrid software offerings, Arista has a variety of customers that they are able to serve.
The bandwidth of the cloud network increases exponentially in a year. I think this can be a potential long term problem for Arista networks. If the bandwidth of the cloud network is efficient, there may be less demand on the hardware side of the business. I think Arista needs to move away from hardware and focus on virtual machines. Virtual machines will still be needed to run programs without a physical infrastructure. Arista is one of the leaders in virtual machine services as well as VMware (VMW). Both companies have legacy operations that need to be scaled back to keep up with newer, more efficient, and faster competitors. A company like DigitalOcean (DOCN) is an example of a start-up with tremendous growth ahead of it. I believe that while Arista will have its place in the virtual machine space, the business will have to be successful in other areas to be a successful business.
Revenue growth has been consistently strong for many quarters. There is a demand for Arista’s products and the company has a long history of successfully navigating the complex data center industry. I believe that as long as the company is able to successfully transition to a more SaaS-based virtual machine ARR model, the profit momentum can continue.
The strong demand for hybrid networks has increased as the demand for data centers increases. Currently, the cloud is only able to handle a limited amount of bandwidth. Much of this overflow data is stored in large data centers. Currently, the only solution to cloud network problems is physical hardware. As these networks grow and are able to run virtual machines (such as DigitalOcean), hardware will soon become outdated in the industry. The equipment is complicated to install, repair and maintain, not to mention the space taken up by the operation. Cloud-based networks will become more efficient for businesses in the long run. Although data centers will still be needed due to locality and the bandwidth available to the hardware. The high costs may be acceptable for a large FAANG inventory, but for start-ups, these costs can lead them to bankruptcy. Overall there are risks, but I think Arista will be able to fulfill the long term growth thesis and move to a more SaaS based platform.
Strong cash generation
Arista’s operations have been consistently strong for many quarters. This was one of the many driving forces behind the 75% increase in the share price in 2021. Arista’s earnings outlook is solid going forward. Many of Arista’s software rating statistics have been overshadowed by analysts’ long-term concern for hardware. However, I think the hardware is just the start of Arista’s long trail for her future growth.
The overall gross margins were similar to that of a software company. However, even though Arista has become popular, their profits do not take into account future growth. With a P / E of 46 and with earnings still high, the company could see a significantly higher valuation going forward. The latest corporate earnings report really gave its stocks a boost. After Arista easily beat third quarter 2021 results, the stock jumped 30% in four days. Even after this monstrous jump in valuation, stocks still have a way to go. This report simply put Arista on the map as a competitive software name that offers products that are incredible additions to their data center products.
Macroeconomic risks to long-term growth prospects
There are significant risks to the long-term outlook. My main concern is the rapidly increasing bandwidth of cloud computing. This technology can potentially eliminate the need for data centers within a few years. There will always be a demand for large data collectors like Facebook (FB) and Google (GOOG) to have data centers, but small businesses like Datadog (DDOG) may not need an operation. complete data center. They can carry out their operations perfectly with their infrastructure in the cloud. There are very few companies that can compare to the diversity of Arista’s offerings and products. In the long term, there is minimal risk to the growth thesis for Arista.
The rating is very high and must come back
The dizzying valuation must go back a little. After the incredible Q3 of 2021, Arista has been relatively stagnant. The business needs a healthy correction before it can enter its growth phase. I want to see Arista move to a more SaaS-based business than a hardware-based business. So that will improve valuations and give the business the boost it needs.
The overall performance of the data center services industry has been relatively healthy over the past year. Nokia (NOK) and MSI (MSI) both reported 50% this year. Arista’s historic run didn’t stand alone, and macro tailwinds have been a big factor in that growth. Profits were strong due to low rates and strong demand. Data center service providers like Arista are still in disarray and need data center service providers like Arista.
Arista has a much higher EV / EBITDA than its peers. This is due to the company’s high margins and growing software-like revenue. I think Arista will continue to overtake the pack and differentiate itself as a new kind of tech conglomerate.
Conclusion and evaluation
I think Arista could be a good choice for 2022. However, I have some reservations about the stock. First, the continued increase in bandwidth in the cloud worries me about the future of data centers. In addition, Arista will need to make some significant internal changes to really gain traction in the years to come. While I believe in the product line and the future of Arista, I have to stay neutral on this article due to the macro risks. I look forward to reading future corporate earnings reports.