Arista Networks (ANET)

Saul,

I am investigating two companies and here is the first one. This is one of MFs RB recommendation. I went into the quarterly reports to get the details but had to fill in some as only second and third quarter reports are available. This company is disrupting Ciscos networking business and is providing software based cloud solutions. Quoting RB best buys:

“When we recommended Arista Networks (NYSE: ANET) in November, we discussed how the company is disrupting mighty Cisco Systems (NASDAQ: CSCO) in networking equipment and data centers. Lo and behold, soon after publication, Cisco sued Arista in District Court, claiming it is violating a handful of patents and copyrights. More recently, it took its complaints to the U.S. International Trade Commission. While we’re not thrilled about the expense and distraction this fight will entail, it’s a clear indicator of just how threatened Cisco is — and we love a disruptive company that’s grabbing market share. (Especially since the lawsuit primarily involves similarities in the user interface, which we think Arista can readily amend if necessary.) The stock has taken a bit of a hit since the suit was announced, which is great news for members who may have been sizing this company up from the sidelines. Now is a great time to take a nibble — revenue is up 73% over the past 12 months, and we expect Arista to keep grabbing market share as companies look to keep up with rising network traffic”

Now I had to fill some numbers to make the different tables complete and these are marked with a ‘*’:

First the revenue numbers:
2Q’13: 83.5
3Q’13: 102
4Q’13: 110*
1Q’14: 117
2Q’14: 138
3Q’14: 156
4Q’14: 166* (company estimate)

Non-GAAP net income numbers:
2Q’13: 12.3
3Q’13: 14.4
4Q’13: 18*
1Q’14: 20*
2Q’14: 23.7
3Q’14: 28.1
4Q’14: 31*

Trailing 12 months income:
Dec 2013 – 44.7
Mar 2014 – 64.7
Jun 2014 – 76.1
Sep 2014 – 89.8
Dec 2014 - 102.8 (~130% w.r.t. Dec2013)

Would love to hear your thoughts.

thanks
Anshuman

Trailing 12 months income:
Dec 2013 – 44.7
Mar 2014 – 64.7
Jun 2014 – 76.1
Sep 2014 – 89.8
Dec 2014 - 102.8 (~130% w.r.t. Dec2013)

Hi Anshuman,

You made a little error and only included three quarters in your Dec 2013 trailing earnings, which is why it was only 44.7, and why the comparison with Dec 2014 is so large.

Best,

Saul

Also Adjusted Net Income by itself is meaningless unless we know the number of shares. For instance it’s a big difference if that $100 million is divided among 20 million shares, or 200 million shares. And what is the share price? and thus the PE? These are things I’d like to know before considering investing in it.

Best

Saul

64.43 m shares outstanding
PE: 73.2

Sweetadeline

I apologize, the 64.43m outstanding shares number is correct, the PE 73.2 is from 9/30/2014 when ANET was priced at 71.12, todays close is 65.06.

Sweetadeline

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Thanks for spotting the error. Even if we add another quarter to it, here is how it will stack up:

Dec 2013 – 54.7
Mar 2014 – 64.7
Jun 2014 – 76.1
Sep 2014 – 89.8
Dec 2014 - 102.8 (~88% w.r.t. Dec2013)

Also EPS numbers are missing for some quarters so its hard to see the pattern

Jun2013: 0.18
Sep2013: 0.23
Dec2013: -
Mar2014: -
Jun2014: 0.35
Sep2014: 0.40
Dec2014: -

thanks

Hi again, Antihuman, Well, you got me interested, and I started researching it with an interest in taking a position. Then I read this post on the ANET board and it gave me a lot a pause. I suggest you read it, at least, before buying.
Saul

I am not an expert in patent litigation. I am instead a technologist who has a patent, testified in court for another patent, and followed closely the Juniper versus Palo Alto Network patent lawsuit.

I am writing to you so you don’t trivialize the lawsuit as a CLI issue.
Although there is a lawsuit for copy infringement for the manuals, this is really, in my opinion, only the smoking gun.
There are 12 patents infringement as well.
When a patent lawsuit goes into court, you have to understand that the jury are chosen to be high school dropouts or graduate. No one would have college degree … The idea is to control the jury by the “experts” with PhD from the top 10 universities, and top lawyers.
It is easy to understand that if someone copied the manuals, why would they stop there ? This is a huge proof. How can Arista Networks say that they would never copy code when they just copied the manual ?
This is very bad. Palo Alto network didn’t have this huge burden.

Another very worrisome data point is that there are 12 patent infringement (Palo Alto networks had 5). Three of these patents were co-authored by Arista Network founders. According to some other articles, there are a rosters of C-suite executive at ANET that co-authored patents. This limit the defense of Arista networks, they cannot invalidate these patents. This was the same strategy used by Juniper against Palo Alto Networks. Furthermore, one of the founders in the lawsuit is actually also suing Arista Networks in a very bizarre twist. This limit the defense of Arista Networks by having a star witness being a loose cannon.

Furthermore, Cisco is going for the jugular against Arista Networks. Cisco has never been a patent troll. This is strategic move, and it will not go away easily.
In this article, read about Mark Chandler (SVP, General Counsel and Secretary) at Cisco System.
http://www.businessinsider.com/cisco-sues-arista-networks-20…

1) Chandler adds that such tactics by Cisco are extremely rare:

“In the thirteen years I’ve been General Counsel of Cisco, I can count on one hand the number of times we’ve initiated suit against a competitor, supplier or customer.”

2) Chandler writes:

The heart of our action regards Arista’s deliberate inclusion in its products of 12 discrete and important Cisco features covered by 14 different U.S. patents. All of these features are being used by Cisco currently and in products we ship to our customers. None of the implementations are incorporated in industry standards. They were patented by individuals who worked for Cisco and are now at Arista, or who at Cisco worked with executives who are now at Arista. These Cisco-created features and implementations are incorporated by Arista in their entirety into Arista’s products.

3) The Article says
"Cisco wants Arista to stop using the infringing technology, a spokesperson tells us. It wouldn’t mind if Arista is forced into re-doing big chunks of its technology. "

Also “Cisco is asking for a jury trial, …”

Finally, this is a pretty bad risk as well:
http://finance.yahoo.com/news/cisco-just-fired-another-shot-…
“In addition a lawsuit filed earlier this month accusing Arista of patent and copyright infringement, Cisco has now gone to another legal body, the US International Trade Commission.”
This is to stop shipping product in the US !!

Conclusion:
This is very bad for Arista Networks when I compare with Palo Alto Networks versus Juniper Networks. In the previous scenario, the patent were much less clear, unrelated to security or a feature. There was no smoking guns (Like copy of documents). They went to trials, which end up as a mistrial. Before re-filing, PANW decide to pay 100 Million dollard to JNPR.

Arista Network has a huge downside. I believe that Cisco System will prevail, so it is just a matter of how much penalties. The worst case scenario is that Cisco prevents ANET to sell in the US. The market cap would go to 1 Billion or less, could be bought by Huawai (or even Cisco) for 2 Billion.

Based on PANW experience, the market will assess a huge penalty, keeping the stock depress to very low levels. I would not be surprised to see the stock tank in the low 30 (about 2 Billion market cap).
They sell for 150 Million/quarter growing at 50% from previous quarter. They have one huge customer (microsoft is 10%). I feel the growth would slow in the 20-30% pretty soon. So, 3-4 Billion market is a fair value range (60$ == 4 Billion). With the lawsuit and a little bad news in a quarter, ANET will see a market cap of 2 Billions (30$/share). At that point, the risk/reward may worth it.

The rule breaker is betting on the cloud network story. I agree with it, but I am fearful that the lawsuit with Cisco will disrupt the ANET strategy and execution. This would lead to a bad quarter, sending the share in a tailspin. The bear momentum would pick up on all the lawsuit worst downside. At that point, nobody would want to touch the share with a 10 foot pole. This is the time were an investment could be made.

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Specifically, that Arista copied Cisco’s manuals will look very bad to a jury, and make the jury liable to believe they copied lots more. Also, that the Arista executives co-authored these patents while working for Cisco, will make it harder for them to defend that they didn’t copy stuff covered by the patents, and harder to say the patents are invalid, etc.

And then we have one of the Arista founders, who is still there, suing the company over another issue, is really complicated.

Without all that nonsense I’d probably take at least a small position, and maybe a full position, but this all adds too much uncertainty. I’m a coward.

Saul

4 Likes

Hi again, Antihuman, Well, you got me interested, and I started researching it with an interest in taking a position. Then I read this post on the ANET board and it gave me a lot a pause. I suggest you read it, at least, before buying.
Saul

Regarding the above reference to another Fool post about the lawsuit against Arista by Cisco alleging patent infringement, here is an interesting and seemingly well-reasoned and supported article on Seeking Alpha putting forth the argument that the lawsuit by Cisco more likely highlights Arista as appealing than threatened.

Worth reading too, along with post Saul referred to as reference to info about possible consequences of lawsuit.

Arista Networks: Shining Bright Like A Diamond Amid Cisco Litigation

Summary
Cisco litigation has made Arista’s stock more appealing.
The current stock sell-off creates great buying point.
Target Price of $85 = 28% upside.

Founded a decade ago by ex-Cisco employees, Arista Networks (NYSE:ANET) is a leading supplier of 10/40/100G Ethernet Switching, using software and open-architecture to address the needs of large-scale Internet companies, cloud service providers and next-generation data centers for enterprises. From 2010 to 2013, their cumulative end-customers base grew from ~ 570 to 2,340 and the customers include six of largest cloud service providers including Facebook, Microsoft, Yahoo!, financial service organization such as Barclays, Citigroup and Morgan Stanley, and some media and service providers, including Comcast, Equinix, ESPN and Rackspace.

According to Crehan Research, Arista achieved the second largest market share in data center 10/40/100 Gigabit Ethernet switch ports, excluding blade switching, sold in 2013. In addition, this market will grow from approximately $6 billion in 2013 to $12 billion in 2017, representing a 19% compound annual growth rate.

In December 2014, Cisco filed the suit in the Federal District Court for the Northern District of California, claiming Arista is violating 14 patents and copying some specific Cisco technologies including the System Database (“SysDB”), Zero-Touch Provisioning (“ZTP”), and Cisco’s implementation of the generic command line interface and CLI command data translation. It didn’t disclose how much money Cisco was seeking in damages. Since then, Arista stock price had a maximum drawdown of 42% as the financial community viewed this event as a negative one for Arista. Arista board member, Dan Scheinman, posted a blog, indicating that the Cisco suit is an “attempt by a legacy vendor that is falling behind in the marketplace to use the legal system to try and slow a competitor who is innovating and winning.”

Before diving into my investment thesis and explaining why Cisco (NASDAQ:CSCO) lawsuit is making Arista more attractive, I’d like to walk you through the networking technology evolution and potential market size, which will help you understand the real reasons for the lawsuit.

http://seekingalpha.com/article/2813935-arista-networks-shin…

okapimoon

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Thanks Saul and okapimoon. I was aware of the lawsuit w.r.t. manuals being copied but the rest looks pretty serious. I think a wait and watch strategy might be better. Otherwise, this technology can realy change things around.

Wow, I wasn’t following the ANET story closely. Without doubt, SDN is one of the biggests things to happen in the world of networking in recent years, heck I would further and say in the past 10 years. The industry is excited, there’s been a ton of research which is now finding its way into the industry, and many consortiums have come up to drive SDN forward. It was clear ANET is trying to snatch Cisco’s lunch but we should note that Cisco is not sitting on its hands. They lead one of the biggest forums looking to standardise SDN.

I looked at this recommendation when it came out but let it go for few reasons:

  1. It wasn’t clear what ANET’s unique selling point was. Many hardware providers have similar offerings. So I couldn’t really justify the premium valuation. Telcos and data center folks generally have a soft spot for the big vendors because of the years of working relations and the comfort that if there’s a problem they can call for help. The smaller player may simply drop off the map.

  2. The legal wrangling with David Cheriton. Cheriton is one of the most respect networking scientists. He was one of the early investors in Google. Waterloo’s school of computing is named after him. This is a guy one wants on your side, not on the other side creating distractions.

(1) & (2) were enough for me to avoid this company. The above legal issues with Cisco further dilute my interest in this company. Too many big distractions for my taste.

Anirban.

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Thanks for sharing your thoughts Anirban. Its the SDN that got me excited too. But will watch from the sidelines for now.

My company works with ANET to attach Cisco installed base in the datacenter. We are kicking cisco’s ass, especially in the financial services industry. But I have not invested in ANET because of the law suit. That multiple has to come down quite a bit or the law suit threat has to diminish significantly right now.

3 Likes

From Barrons

http://blogs.barrons.com/techtraderdaily/2015/01/16/arista-p…

Pac Crest Slashes Target on Cisco Lawsuit Risk

By Tiernan Ray

Pacific Crest’s Brent Bracelin today reiterates an Outperform rating on shares of Arista Networks (ANET), but chops his price target to $80 from $115, writing that there is increasing risk of disruption to the networker from a lawsuit filed against it by Cisco Systems (CSCO).

Cisco filed suit against Arista on December 5th in the Federal District Court for the Northern District of California, alleging infringement of 14 patents.

Bracelin writes that Cisco’s been “a fierce competitor” for more than three years, “as shown by aggressive discounting in head-to-head deals with Arista,” and it has taken “the next battle to the courts in an effort to slow Arista’s share gains.”

Bracelin compares this suit to Cisco’s previous suit against China’s Huawei, and also a suit by Juniper Networks (JNPR) against security vendor Palo Alto Networks (PANW):

Cisco’s lawsuit against Huawei, filed in 2003, was not ultimately successful in slowing share losses, nor was Juniper’s lawsuit against Palo Alto Networks. Nonetheless, the Huawei lawsuit, aggressive discounting by Cisco and offensive commentary from Cisco’s leadership directed at Arista all point to an increasingly competitive battle between Arista Networks and Cisco emerging for 2015.

He writes that the lesson from both cases is that it takes years for these things to resolve themselves:

At a minimum, this lawsuit increases execution risks in the coming year and could serve as an internal distraction for management, as well as an external distractions for customers. There is also the potential for some customers to temporarily pause spending as they evaluate and test Cisco’s new Nexus 9300 switching family of products, which began shipping in October. For now, using the Juniper vs. Palo Alto Networks lawsuit as a proxy, all that we truly know is that it will likely be years before we see a potential outcome. For example, Palo Alto Networks didn’t settle with Juniper until May 2014, more than three years after the formal lawsuit was filed.

On the positive side, Bracelin thinks Arista’s role in enterprise networks can increase as some customers look for a way to combine server, storage and networking — a trend called “hyperconvergence” — without being reliant on Cisco:

Hyperconvergence trends clearly increase the competitive overlap between incumbent server, storage and networking partners. We see Arista’s role increasing over the next three to five years as traditional storage partners of Cisco also look to bundle integrated, hyperconverged IT stacks using a different networking technology in order to differentiate themselves. Bottom line, we are doubtful customers will want an all-Cisco compute/network tier, which leaves the door open for a next-gen networking supplier to partner with these incumbents in a more meaningful way. Arista’s highly programmable feature set could be ideal for a hyperconverged stack.

A big rich company setting out on the litigation path means either that they really believe they have meaningful intellectual property, or that they don’t, but want to distract competitors and force them to spend money and management attention on the litigation rather than on the business. Judges and juries usually have no knowledge of the issues involved and can be swayed by paid “expert” testimony, so they may win even if they have feeble case. Especially when one company has more money to hire “paid gun” experts.

Which is the case with Cisco? I suspect they are feeling competitive pressure.

The lawsuit has probably been discounted by the market. So now might be time to look at Arista hough I know nothing about the underlying business.

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From Seeking Alpha News Feed today.

Stifel’s top tech picks for 2015 • 8:58 AM

Arista Networks (NYSE:ANET): Price target $95 vs. current $64.28. Implied upside: 48%…

Hi Anshuman,

I have put ANET on my radar, just to see how my decision to not buy is working out. Others must also be worried about the Cisco lawsuit as the price is moving steadily down in a slightly up market. (Which doesn’t mean it can’t turn around tomorrow, but will keep watching).

Saul

1 Like

Thanks Saul,

I am of the same opinion. I am keeping an eye on this one. I’ll wait for things to get a little more clear before starting a position. In the meantime stock price could go either way.

Anshuman