EUR 850.00 For Business Accounts Only

Morningstar | Benefiting From Hyperscale Cloud Provider Spending, Arista Posts Another Record-Setting Quarter

Arista posted another record-setting quarter as revenue and operating results exceed our expectations and consensus. Strong orders from the hyperscale cloud providers drove a 29% year-over-year revenue growth while lower-than-expected sales, marketing, and general expenses increased operating margin by 28% versus the previous year. After incorporating the earnings information and adjusting our model for future expectations, we are maintaining our fair value estimate of $261 per share for narrow-moat Arista. With shares up around 8% after hours to our fair value estimate, we caution investors to wait for a wider margin of safety.

As compared with the previous year, Arista has kept gross margins consistently around 64% as it expands its customer base beyond hyperscale cloud providers. Cloud titans, who exhibit strong price power, still represent the dominant vertical for Arista and management commented that the enterprises segment is growing the fastest. Non-GAAP operating income margin was 37% for the quarter compared with 39% in the prior year due to increased R&D expenses for additional headcount and design activity. Looking ahead to next quarter, Arista expects $582-$592 million in revenue with non-GAAP gross margins of 63%-65% and non-GAAP operating margin of about 35%. We model Arista exceeding its guided revenue range, landing in the upper end of gross margin, and slightly exceeding operating margin guidance.

Arista introduced its 400 Gb products, based on merchant silicon, in the quarter and management stated that 400 Gb trials should occur in the first half of 2019 with deployments in the second half of 2019. With the 100 Gb upgrade cycle still occurring for the next two to three years, we believe that Arista has positioned itself to win earlier adopters of the upgraded speed. Cisco recently announced a similar 400 Gb roadmap, but we expect Arista's EOS software to present a switching cost for firms considering the latest networking technology.

Arista completed its first two acquisitions in the third quarter. We believe that Mojo Networks will strengthen Arista's campus offering as the company migrates into the campus segment and that MetaMako, a provider of low-latency FPGAs, will help Arista further penetrate the financial segment for high-frequency trading with extremely fast and accurate time stamping. As Arista expands its market presence outside of data centers, we expect the company to possibly tuck-in software defined networking management and analytics firms.

Arista does not expect material revenue from the campus market until the second half of 2019. We believe the migration to the higher-margin campus market will help expand Arista's operating margin beyond 33% by 2022. Additionally, we believe that Arista's switching cost moat source may further strengthen as existing customers deploy Arista products across campus networks for continuity.

Arista announced a short-term global fee of 3.3% on top of all orders to help with their 10% product tariff while the company's sourcing team works to reduce its dependency on Chinese goods and manufacturing. We like that Arista is actively working on tariff mitigation, and that its 3.3% fee is lower than Cisco's increases (which differ per product). 72% of sales are derived from the Americas and management stated that its global markets performed well but are currently ramping.