This “pick” is more of a company to keep your eye on in the coming year. Watch it every now and then, see how things develop. But keep the camera at home for goodness sake!
What is it?
Tech companies are an interesting beast to look at. They’re in a complicated and ever-changing environment. You must understand the company, its competitors, and the market. If all checks out, then check valuation.
Arista (first name basis?) according to their website provide, “cognitive cloud networking for large scale data center and campus environments.”
“Arista has a prestigious set of customers, including leading global technology companies in financials, web 2.0 and cloud/service providers, building public and private cloud computing systems. Arista builds scalable data centers for many Fortune 500 companies and delivers products worldwide.” –https://www.arista.com/en/company/company-overview
In a nutshell, everyone knows hardware and software. Arista combines the two and creates a network for large customers. This means they create the ways that Google, Facebook, and Microsoft all are collecting, storing, and utilizing their data. Also, they are creating storage systems for massive financial companies. In addition, they also are creating the cloud networks that college campuses are utilizing for their students. This campus segment is a newer market for ANET and is growing very rapidly.
***This is a brief overview. It does not go into all the details necessary. Mostly because this is an investing blog and not your nerdy uncle’s technology newsletter.
The 2010’s has been all about data. The world is evolving to rely on data more heavily to effectively advertise, save unnecessary costs, help NBA teams score more points, or how to properly launch new brand releases.
With all these catalysts, Arista’s stock price took off faster than the pretty girl at the bar you tried to hit on. Besides your love life, all was good in the world. Then, the protective boyfriend (Facebook and Microsoft) showed up and decided to start drama.
The two tech titans (always get in the daily alliteration) drastically cut their spending on their cloud and data centers for 2020. All would be fine but these two also make up 40% of Arista Network’s revenue. Now, ANET’s revenue will be flat to down low single digits for 2020.
The Street hasn’t been too understanding, for good reason.
Every company, like a good movie franchise, has its ups and downs. Die Hard, Cars, and Indiana Jones were all fantastic original movies. Then, Die Hard 2, Cars 2, and The Temple of Doom made you feel like puking monkey brains, in a tow truck, on the way to the airport. The future was dark and full of terrors. After a bit, the third movie restored all the franchises; a legacy was built, and no other movies ever came out to tarnish those reputations again. The End.
Arista will be fine in the long term. In the next decade, companies will still need help making data networks. Not like the world will stop piling up data or stop using more and more computers anytime soon. This brings us to valuation and company performance.
The company is currently valued at $17 Billion. Here’s the usual suspects:
|Price/Book||Price/Earnings||Price/Cash Flow||Forward P/E|
Initially, these numbers might seem unappealing to tech growth investors, reasonably so. However, this doesn’t consider that Arista Networks has issued a $1 billion stock buyback program funded from operating cash flow, has $2.7 billion in their bank account (16% of current market cap), and has no debt on their balance sheet.
In addition, Fundasy Investor looks at companies that internally grow their capital quicker than the market (ROC). ANET has averaged close to 22% ROC since going public (31% in 2019). Their return on assets (ROA) and return on equity (ROE) are also equally impressive with averages being 15.4% and 23.5% respectively.
On their share buybacks, they’ve averaged $186 per share on their buybacks (15% below current prices), which tells me that management isn’t stupid and knows what their company is worth. They’re not buying stock back at the $240+ range. This also means that if the stock goes below $186, they might be willing to buy even more shares back at a discounted rate.
The company had a history of issuing shares once the stock price was increasing in the 2014-2018 range but stopped in 2018 and started a buyback program. I like that management, unlike most tech companies, is aware of their share value and effective capital raising. This is shown in their ability to grow revenue while not compromising their profitability.
($ in millions)
Summing It All Up
I think that right now, we’re in about the 2nd Act of Die Hard 2 or The Temple of Doom. Eventually, the two tech titans, Microsoft and Facebook, will start spending money on infrastructure again. The college campuses are also a massively growing segment that will pay off in the next few years. In addition, there are industry trends that will cause ANET to succeed regardless in the long term.
The revenue drop will occur this year and I’m hoping the drop isn’t entirely baked into the current share price. If the price goes to the $180-190 range sometime in 2020, the price to cash flow would be around 15 (based on 2019 cash flows), not including any buybacks, or the $2.7 billion in cash. If it gets to around 180 a share in the next year, it would definitely be worth considering opening a position.
All in all, that’s not too bad of a valuation for a tech company. Maybe keep those binoculars handy when you watch this name.
If you liked this article please subscribe, share it to social media, read it to your kids at night, or whatever’s your thing!
***Here at Fundasy, we have no position in ANET because we’re patient super awesome investors. We strongly recommend that any investor do their own research before investing and not rely on strictly our data for their investment decisions.
Of course, thank you for reading and commenting! 1. I think it’s possible to get a higher multiple than 25x…
Hi, First of all I appreciate your analysis, quite good and also I learn about fair value compensation. I have…
If(valuation == good), Then (Force = k*Distance (k=mx) –> 2x$$), Else (Wait) Figure that one out, you fancy ISEN major
Unleash the spring! After I build my full position of course.
Thank you so much for your comment! *Apparently* revenue missed analysts estimates by 2%. Personally, I’m okay with 97% revenue…