In May, AI chip maker Nvidia became the bellweather stock for investors seeking to ride the Generative AI wave. Since peaking in August, Nvidia stock has lost 18% of its value.
On October 31, the baton was passed to Arista Networks
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, a fast-growing maker of cloud computing network gear, posted expectations-trouncing quarterly results.
With help from the Generative AI tailwind, Arista soared past its 12 month price target of $172, about which I wrote in June.
Has Arista stock peaked or will it keep rising? Here are four reasons Arista is well-positioned to ride the Generative AI tidal wave:
- Big market for AI networking
- Compelling customer value proposition
- Customer-focused innovation
- Outstanding leadership team
If Arista keeps beating and raising in future quarters, its stock could blow through its 12 month price target of $219.
Arista’s Boffo Third Quarter Earnings
Arista’s stock responded favorably to its third quarter 2023 earnings report which exceeded investor expectations.
Here are the highlights, according to Investor’s Business Daily:
- Q3 Revenue up 28% to $1.51 billion — $30 million more than the analyst consensus.
- Q3 Earnings per share up 46% to $1.83 per share — 25 cents per share more than the analyst consensus.
- Q4 revenue guidance of 4.4% growth to $1.525 billion — $55 million more than the analyst consensus.
Wall Street reacted favorably to Arista’s report, Here are four examples:
- Gains in market share and higher margins. “Share gains in enterprise data center, campus networking, and cloud networking are driving upside,” said Barclays analyst Tim Long in a report. “Margins continue to improve on better component pricing and operating leverage,” IDB reported.
- New orders from existing customers. Jefferies analyst George Notter estimated Oracle now accounts for 5% of Arista’s sales. Analysts also expect Arista to win more orders from Alphabet, IBD
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wrote. - Winning in large enterprise market. Arista is boosting its market share in among large companies, government agencies and educational institutions — dubbed the large enterprise market. Arista “is seeing strength among traditional high-tech and financial customers as well as newer verticals such as health care and education,” wrote Goldman Sachs analyst Michael Ng in a client report.
- Potential boost from Generative AI. By 2025, some analysts expect customer investments in artificial intelligence infrastructure to increase demand for network bandwidth Arista’s products supply, IBD noted.
Big Market For AI Networking
The market opportunity for such AI networking is considerable. As I wrote in June, Morgan Stanley
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analyst Meta Marshall estimated AI networking will be an $8 billion opportunity by 2028 “with Arista being one of the biggest beneficiaries.”
Compelling Customer Value Proposition
While not alone in developing technology for speeding up generative AI, Arista offers a uniquely valuable product. Cisco Systems and Juniper Networks supply proprietary technology. Other vendors offer so-called white box solutions which save money by running bespoke software on commodity hardware rather than expensive, proprietary switches.
Arista provides customers a hybrid approach depending on the type of application. “We are comfortable with the idea of a white box since that is how we started as software running on everyone else’s hardware. We want to provide customers what they need. For less mission-critical applications, they can use white boxes. For specialized applications — such as turnkey healthcare or financial solutions — they need Arista.,” Arista CEO Jayshree Ullal told me in May 2023.
Customer-Focused Innovation
Arista innovates to keep its customers buying. “We look at our talent, the market potential, and we listen to the customer,” Ullal told me. “They ask us to do more. High performance data switching was number one. Next year, 70% said ‘You should be in the campus.’ We went from routing, to campus, to wide area (Ethernet).”
Arista builds or acquires to add “natural adjacencies” to its product portfolio. An example is security for which the company built “a security network telemetry.” When Arista saw it was missing wireless, it made an acquisition.
Arista wants to retain the services of the entrepreneur who founded the companies it acquires. “They should fit with our culture, share our cloud vision, and one plus one should be greater than two. We want to get the entrepreneur to integrate with us and deliver customer solutions,” she said.
Outstanding Leadership
Ullal has been CEO since September 2008. In my view, she is among the best CEOs in the technology industry. Between 2010 and 2022, Arista revenues grew at an average annual rate of 33%. Since going public in June 2014, Arista stock has increased at an average annual rate of 31%.
Here are some ways Ullal contributed to the company’s success:
- She helped the company recover from the Lehman Brothers bankruptcy. In 2008 Arista’s client — Lehman Brothers — filed for bankruptcy. Fortunately, the technology Arista supplied Lehman helped other financial institutions survive the financial crisis, she told me.
- She evolved from being very hands-on to setting strategic direction and empowering experts. Her leadership style changed as the company has scaled through three phases. “In the first phase, I was jumping into everything. As we reached $1 billion to $5 billion in revenue, I worked with co-founder and chair Andy Bechtolsheim and co-founder and chief technology officer Ken Duda and the leadership team over 10 years. My role was to look at the strategic direction of the company and to empower experts. In the third phase, as we aim to achieve revenue in the multibillions, I am thinking about Arista’s purpose and its platform as we diversify to security and availability,” Ullal said.
- She built a culture of low-ego and collaboration on behalf of customer success. At Arista, she built a culture that encourages people to work together to make customers successful, she told me in May. “When a startup is trying to get off the ground, the CEO often feels compelled to get involved in everything. Such centralized control limits a company’s ability to reach escape velocity. At that limit, the company faces a choice. Either the CEO learns how to delegate and empower people or the board replaces the current CEO with a new one who can,” she said.
- She enhanced Arista’s bench strength. Ullal feels a fiduciary responsibility to build the next generation of Arista’s leaders. “For succession planning, I have one or two candidates internally or externally. It starts with me and others to build bench strength. There are people in their 40s, 50s, and 60s who might want to retire. For the next CEO, we need an operator, someone who can embrace our vision and fit it with their style,” she explained.
Where Will Arista Stock Go Next?
Arista shares are expected to rise — but not much. Based on 16 Wall Street analysts offering 12 month price targets for Arista, the average price target is $218.79 — representing a 5.8% change from the last price of $206.79, according to TipRanks.
Not everyone is so bullish. One analyst views Arista as very overvalued. Morningstar
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analyst William Kerwin set a price target of $160 — implying Arista shares are 23% too high.
Kerwin sounds bullish — but thinks the company is overvalued. “Arista is putting together an impressive year of results in 2023, reflecting market share gains in the enterprise market and ongoing cloud titan spending driven by artificial intelligence buildouts. We see Arista as the preferred choice for the highest-speed networks with its hardware and software design prowess, allowing it to be a beneficiary of cloud AI spending and reflecting its wide economic moat,” he wrote.
I think Kerwin is too pessimistic. After all, if Arista sustains its trend of beating investor expectations, its stock price will likely keep rising. I am not sure what Kerwin things could trip up Arista.
So I would not bet against this AI networking juggernaut.
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