Arista May Still Thrive Even If Cisco Wins Lawsuit

Network gear maker Arista Networks (ANET) has spent more than a year watching its share price bob up and down in response to a lawsuit brought against it by rival Cisco Systems (CSCO), the networking giant that accuses Arista of stealing its technology.

Expect more stock price volatility in coming months as legal and regulatory bodies decide whether Arista infringed on several Cisco patents involving network switches and other gear. That’s what Cisco accused Arista of doing when it filed a complaint with the International Trade Commission (ITC) in December 2014, along with patent and copyright lawsuits in federal court.

Since then, Arista shares have reflected shifts in the way the legal battle has progressed. Its stock fell hard in mid-September on reports ITC attorneys determined that Arista infringed on three Cisco patents. Less than a month later, Arista recovered some of those losses after the U.S. Patent and Trademark Office said it would consider the validity of two patents on router technology owned by Cisco.

Regardless of how the legal battle ultimately plays out, a growing number of analysts sound confident that Arista’s strong technology and customer relationships will ensure robust financial growth over the long-term.“We’re convinced that, while Cisco will likely win in some of its patent claims, it will not disrupt Arista’s business,” Oppenheimer analyst Ittai Kidron noted in a Jan. 4 report upgrading the stock to outperform.Guggenheim Securities analyst Ryan Hutchinson offers a similar view, saying that even if Arista is found to have infringed on certain patents, any short-term weakness in the company’s stock price would be “a buying opportunity” thanks to its core strengths.

“We believe that a full injunction against Arista’s products is unlikely,” Hutchinson noted in a report. “In the event of partial injunction, manufacturing and/or R&D workarounds would not be overly difficult. As such, we would focus less on the near-term twists in the legal saga than Arista’s strong momentum, share gains and successful expansion efforts.”

That expansion has helped Arista become a much bigger player in recent years. The company is expected to post more than $830 million in revenue for 2015, up from less than $200 million as recently as 2012.

“Arista continues to gain market share at the expense of large incumbents such as Cisco and Juniper Networks (JNPR),” said Mark Sue, analyst at RBC Capital Markets. “Its rate and breadth of new customer wins give us added confidence that the top-line growth rate may be sustainable beyond just the near term.”
The legal battle is set to take another turn Wednesday, when the ITC is scheduled to make a final initial determination on the first of its patent cases involving Arista and Cisco.

“Following the final initial determination, the ITC will review the administrative law judge’s initial decision to determine if a violation has occurred, and whether an exclusion order is necessary,” Hutchinson noted.
If infringement is found, he said, Arista’s stock price will likely take a temporary hit. Investors should be used to that by now. In 2015 alone, the company’s shares ranged from a low of 56.11 in February to a high of 88.56 in June. The stock currently trades near 60 and is down about 19% since the beginning of the 2016.

But there’s nothing volatile about Arista’s financial performance. The company has grown year-over-year revenue at least 40% in its first five full quarters since going public in June 2014. Earnings have risen at least 47% over the same time period.

Arista has a wide portfolio of products, ranging from extensible operating systems, network applications and Ethernet data switches to cloud networking gear that manages traffic between Internet users and the data centers of major clients like Facebook (FB), Yahoo (YHOO),  eBay (EBAY) and Microsoft (MSFT). Arista also has partnerships with high-profile tech firms such as HP (HPQ) and EMC (EMC).

Its latest product update came on Jan. 19, when it announced the next phase of Arista EOS, a Linux-based network operating system that gives customers real-time migration from legacy enterprise silos to private, public and hybrid cloud networking. The new phase features NetDBTM, a network-wide state repository designed to increase network scalability and efficiency.

New product introductions provide one growth avenue for Arista. Another comes from expansion in international markets, which currently provide less than one-quarter of overall revenue.

“Arista is expanding its global footprint methodically,” Hutchinson said. “It currently has a presence in over 18 countries and continues to build out infrastructure and pipelines. We believe international expansion can help sustain solid top-line growth, while driving operating leverage.”

The company is due to report 2015 fourth-quarter results after the close on Feb. 18. Analysts expect earnings of 61 cents a share, up 15% from the prior year. Revenue is seen rising 38% to $240.3 million.
“We expect the company to beat expectations for the quarter and to guide in-line to slightly ahead of consensus,” Hutchinson noted.

He sees growth coming from a couple of areas. One involves switching equipment that makes use of Broadcom’s (BCOM) “Tomahawk” chip, which is designed for network switch speeds of 25 gigabits per second, or 25G.

In September, Arista joined Cisco and Dell as the latest major vendor to unveil data center switches that support 25G, 50G and 100 billions of bits per second (Gbps) Ethernet. In addition, Arista upgraded its operating system software to support the new switches.

Hutchinson expects customer interest in Tomahawk “to sustain cloud demand” through the first half of year.
Another opportunity is tied to Broadcom’s Jericho chipset, an area where Arista will target technologies such as edge routing. As the name suggests, edge routing occurs at the edge or boundary of a network and helps ensure connectivity of the network tp external networks, a wide area network or the Internet.

“We believe there are a handful of multiyear deployment opportunities worth well north of $100 million tied to the adoption of the Jericho chipset in (the second half of 2016) and into 2017,” Hutchinson said.