ANET: Cash Generating Monster

Investment Analysis Clubs Saul’s Investing Discussions
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Hi all,

I’ve been a long, long time reader and haven’t posted yet (since WPRT days). Saul, can’t thank you enough, as you’ve been one of the most influential teachers in my investing journey. I’ve been up 50%+ the last 3 years, including 2018 (yes, I know that is insane). 80% of my portfolio is in high-growth tech, but I utilize options for specific arbitrage situations in cash flow-rich companies, e.g. FOSL earlier this year.

Also, I hope to bring a new idea to the board this weekend.

Back to ANET. There has been a lot of discussion about the growth rate, margins, etc. I understand the importance of those numbers. And yes, this board is focused solely on high growth stocks. But I want to take a big step back, and take a moment to reflect on the last few years of cash flow and cash balance. After all, that is what we are all in this for, cash! We are witnessing a true behemoth emerging, with lots of financial optionality.

Free Cash Flow
March 31, 2018 190M*** - (approximation based on past operating cash flow numbers)
Dec. 31, 2017 180.54M
Sept. 30, 2017 203.24M
June 30, 2017 74.34M
March 31, 2017 158.22M
Dec. 31, 2016 60.63M
Sept. 30, 2016 -37.01M
June 30, 2016 60.76M
March 31, 2016 68.50M

Cash on Balance Sheet
March 31, 2018 1.7B
Dec. 31, 2017 1.536B
Sept. 30, 2017 1.343B
June 30, 2017 1.125B
March 31, 2017 1.043B
Dec. 31, 2016 867.83M
Sept. 30, 2016 800.15M
June 30, 2016 823.82M
March 31, 2016 762.25M

Their cash is up almost 70% YOY, and TTM free cash flow is up 167%. That is incredible. This isn’t a pre-earnings company with 30%+ revenue growth rates (like SHOP, AYX, etc.). ANET is already printing cash, and according to Jayshree (CEO), they are in the 1st or 2nd inning of 100gb transition.

I have owned ANET for 2+ years now, sold a little near $300, and have been a buyer in the $240-250 range. Again, growth rates will certainly decelerate from current 40%, and they are guiding against two quarters of extremely difficult comps (50% growth in Q3 and Q4 of 2017), so the price may drop more, but long-term this company has incredible amounts of growth ahead, a truly special CEO and team, and the financial flexibility to execute. Long-term ANET will be more than fine…

Best of luck,
Stephen

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Wow, great first post, Stephen!

Thanks for sharing.

Jim

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Stephen the exact number is just shy of $189 million. Cap ex were ~$6.5 million.

Arista continues to dramatically cut expenses at much greater rate (and sometimes not rate but in actual numbers) than the rate of growth of revenues.

This is a magnificently managed company who clearly has pricing power.

Arista will have probably, more than $800 million in free cash flow this year. They will have more than $2 billion in cash. In 2019, it is not unlikely that they will have more than $1 billion in free cash flow and end 2019 with more than $3 billion in cash, and so on.

No analysis of Arista can be complete without adding all this future cash into the pile because Arista’s enterprise value will continue to come materially down every year as the free cash flow grows and the money piles up.

Arista really has little interest in buying other companies or much use at all of this money. That may change of course.

The market, however is paying up for growth, and will value Arista more as a high growth bond, it if stops giving it credit for a lot of growth.

This is like what Microsoft looked like in its earlier days. Microsoft never grew faster than 100% per year as a public company, but year after year 50, 30, 40% per year, for a long time, with enormous cash flow being built up.

This is the reason to hang onto Arista and buy more, if one is leaning that way.

I have considered this, and that is why Arista is still a substantial holding of mine. Arista at one point was far more than 50% of my holdings. So it was sensible to spread things out (I had sold my prior SHOP profits to obtain such a large Arista holding, and Arista did not disappoint from there). I have since reversed that and have more SHOP shares now than before.

But for all the yay and nay of Arista, the cash flow generating power of Arista is a very rare thing for such a young company in such a competitive market.

The real and legitimate fear is, look at Juniper. Look at Cisco. Both companies also have incredible cash creating engines. But their growth slowed, and despite the ability to print cash, the multiples collapsed, they became valued more like a high growth bond instead of growth companies.

I think that is both sides of the Arista argument. Will Arista remain a 25%+ long-term growth company, or as is the fear of some (and remember Juniper was a young company when this started as well and then they hit a wall around $5 billion in revenues) succumb to white boxes, and the Cisco wall in the enterprise market, and become a nice fat cash cow growing at the rate of the market.

The former appears to be far more likely, that is my opinion. But worthwhile pondering things for a bit.

Tinker

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So what are they going to do with all that money? Hopefully not some dumb acquisition.

If they can keep up even 25% growth for 3 years that is a double.

I really think the problems are mostly lumpiness in the Cloud and over conservatism in Enterprise where it is Monkey see Monkey do. But the valuation is too high for me to want to expand my position.

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With humans being the ones to mess up the planet and destroy everything with nuclear weapons, Monkey resents the stereotype. Harrumph.

As for ANET: this humble monkey sees ANET as a profitable investment from these prices and is doing nothing but watching the network weenies make the bananas on the regular. Having too much cash is rarely a bad problem to have, yes? Maybe Tesla can learn something from Arista?

Hugs,

Monkey (long ANET + TSLA)

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Hello Tinker,

I think that is both sides of the Arista argument. Will Arista remain a 25%+ long-term growth company, or as is the fear of some (and remember Juniper was a young company when this started as well and then they hit a wall around $5 billion in revenues) succumb to white boxes, and the Cisco wall in the enterprise market, and become a nice fat cash cow growing at the rate of the market.
My view is that the cloud development is in early innings. This is one of the most productivity/effeciency phenomenons for business/industry in my lifetime. Arista’s networking solutions seem to be an enabler of that. A couple of quarters last year Arista grew at rates that were deemed almost incredible. In the conference call yesterday when management was asked how the cloud titans could be spending record amounts of capex in Q1 and Q2 and Arista’s growth slow; there was a reference to the nearly 18 month lag from 1st capital spend in a new facility until the networking component is delivered. Thus, there was a bulge last year (IMO) and there will be another beginning in Q4 18 or Q1 19. In the meantime, 25% growth or 30% wherever they come in, will boost eps at a greater rate and (IMO) more than support the current valuation.

As you have pointed out many times, companies this stellar are not acquired at bargain prices!

Best regards,

Mike

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Thanks Mike.

As you can see my usual initial cynicism (which you need sometimes) often ends up turning into clarity and vast optimism. Both Qazulight’s comments, and your insight into the lag time of data center build (something we had discussed but never got to the gist of it, as real estate and the mundane stuff is most of the cost of data centers - like air conditioning) puts nicely together the points that Arista and the analysts could have made a bit easier to pull out.

But is the way it is.

Well, good for us. Good discussions guys.

I may get back to doing nothing with my shares other than buying systematically, and Arista may just be the buy at this point in time.

Thanks all.

Tinker

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it is not unlikely that they will have more than $1 billion in free cash flow and end 2019

Unlike software, Hardware prices go down. You have to come up with newer products with better features to sustain price and margin.

Do you see ANET has enough in the pipeline to continue to generate higher price per unit?

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Kingran, Arista is already 30x Lexi expensive per port for routing than is Cisco. I have not confirmed this but Arista seriously claims that Cisco could give away its product and the total cost of ownership would still be higher w Cisco.

Arista builds hardware using merchant silicon w contract manufacturing. Basically generic stuff, except in their spine and leaf designs. 90% of their R and D is spent on software. Hardware is a lucrative wrapper around it.

SDN is based on software. This said, Arista has put out multiple new products in the last two weeks or so. Today is their cognitive product for the campus environment. Their first foray into the campus market.

So no, they are not a hardware proprietor.

Tinker

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Do you see ANET has enough in the pipeline to continue to generate higher price per unit?

The CFO, Ita Brennan, said today during her Analyst Day presentation that the company has historically grown total profits by over 40% year-over-year through a combination of revenue growth and increased operating margins. If I understood what she said correctly she expects that this performance will continue.

Management made it very clear this is a software company - they said this numerous times during today’s event.

Over the next couple of days the company will be participating in two conferences that will be available over the web:

Jefferies 2018 Global Technology Conference
May 10, 2018 01:15 PM PT

and

46th Annual J.P. Morgan Global Technology, Media and Communications Conference
May 15, 2018 12:40 PM PT

You can access these webcasts here:

https://investors.arista.com/Events/default.aspx

Disclosure: networking is not my field of expertise, just trying to let folks know what I saw today.

Frank - long ANET, see profile for all holdings

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