Why Cisco and Oracle Should Fight for Aruba Networks

A lot has happened in tech since our last discussion of Aruba Networks (NASDAQ: ARUN  ) . In an effort to regroup, Dell has gone underground and Oracle (NYSE: ORCL  ) has picked off Acme Packet (UNKNOWN: APKT.DL  ) . Essentially, consolidation and "strategic partnerships" seem to be the theme, which leads to the constant question of "Who's next?"

It's hard to not consider Aruba Networks. Not only has this company been delivering solid revenue growth, including an almost 30% average the past five years, but the company's WiFi and WLAN products are well regarded in the market. And even though there have been constant concerns that it would get eaten alive by such behemoths as Cisco and F5 networks (NASDAQ: FFIV  ) , the numbers tell a different story. And if the company's beat-and-raise second-quarter earnings is any indication, this growth story is far from over.

Strong beat-and-raise affirms confidence
Aruba beat on both the top and bottom lines. Revenue soared 23% year over year and 8% sequentially. Product revenue, which comprises 84% of Aruba's sales, advanced roughly 26% year over year and 10% sequentially. While service revenue grew 20% year over year, it was a bit weak -- shedding 3% from the first quarter. But that's not entirely a surprise given the sour mood of this earnings season, which included several so-so reports from the likes of F5, which followed lowered guidance.

Profitability was also strong. Non-GAAP net income surged 41% and posted earnings per share of $0.22. That's all well and good, but equally impressive are the company's margins, which continue to show strength and helped amass $46 million in cash flow. On a sequential basis, gross margin advanced 50 basis points, while operating margin grew almost 1%. Likewise, Aruba showed better cost management this quarter. Although operating expenses grew 15% year over year, it was 5% slower than the first quarter. Over all, this was a dominant quarter across the board.

Aruba capped it off with a raise, guiding the low end of third-quarter revenue to arrive almost $1 million higher than Street estimates. On the news, the stock soared more than 20%, which means that since the stock hit a low of $12.37 last July, shares are up almost 120%. And, more importantly, this beat-and-raise quarter validates the confidence that investors have shown on this stock. However, and equally important, it affirms why Aruba is one of the best M&A candidates on the market.

Waiting for the phone to ring, if it hasn't already
Cisco
(NASDAQ: CSCO  ) should come calling any minute now. With the wireless LAN market reaching $1 billion in the recent quarter, Aruba's industry-leading product portfolio is too valuable to ignore. Plus, with products such as Aruba Instant Enterprise, the company is beginning to deliver some higher win rates. The fact that Instant Enterprise is controller-less, which means it does not require any physical or virtual controllers.

Granted, Cisco's acquisition of Meraki falls along similar lines. But Aruba's dominance in "Bring your own device," or BYOD, can help Cisco offset its exit out of the application delivery control (or ADC) market, an area where it could not keep up with F5. Meanwhile, F5's recent acquisition of LineRate, a new hybrid cloud solution for mobile application management, puts F5 in a position to steal market share (among others) Aruba Networks. Essentially, the dominoes are beginning to form.

The other possible candidate is Oracle, which has been slowly building its one-stop-shop enterprise objectives with via M&A, most recently buying Acme Packet. But for Oracle, playing "defense" could just be the strategy, given that Acme Packet already competes directly with Cisco, which recently acquired Intucell. Oracle wants what Cisco has. And Aruba's BYOD dominance in mobile WiFi can help Oracle leverage Acme Packet's 40% lead in the session boarder control market. Plus, not only does this give Oracle an entry in the realm of consumer products, but it also presents Oracle an advantage over cloud rivals such as Microsoft and salesforce.com.

For now, Aruba is an island with considerable growth. And as long as mobile devices continue their uptrend, there's no stopping this story. And despite the recent run in the stock price, these shares can still climb north of $30 on the strength of long-term free cash flow growth. In that regard, it would be a mistake for Cisco and Oracle to let this company get too expensive.

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