Arista Networks' (ANET -2.29%) stock hasn't gotten much love lately. The pioneer of cloud-based networking hasn't had the smoothest of transitions since its growth trajectory started to slow a few years ago, and various delays in new product are getting pushed back into 2021. The result: A stock that has been stuck in neutral since the beginning of 2018.
However, the next five years could be very different. After plunging with the rest of the market during the worst of the lockdown to halt the spread of COVID-19, Arista shares have rallied and are now up 11% in 2020 to date (compared with negative 4% for the S&P 500). Still ranked as the industry leader in data center and software-defined networking by tech researchers Gartner and Forrester, not to mention cloud computing looking more important than ever before, the future remains bright for this technologist.
First, the bad news
Let's dispense with the negative first. After more than a decade of fast and steady growth to build out infrastructure, the "cloud titans" (Microsoft, Amazon, and Alphabet) are slowing down in the purchasing of cloud hardware. That's bad news for Arista, since it disclosed that 40% of its revenue was derived from "cloud titans" in the first quarter of 2020. Other enterprise-level cloud purchasing declined at the start of the year, a situation that could get worse as many companies are tightening their belts now that recession is here.
Of course, hardware has limited life expectancy, and computing needs are on the rise. The boom in video conferencing amid the current crisis demonstrates this, and infrastructure needs to be updated so it can handle all the extra data traveling across the web. That's where 400G technology comes in. Think of the switches, cards, and fiber optic line like a freeway system, and 400G like a freeway with more lanes and a higher speed limit.
Arista has been developing product to address these needs, but trials with partners (like telecom networking manufacturer Ciena) are still ongoing. Production and shipping won't occur until 2021, and demand may take a few years to become significant to Arista.
Plenty of long-term positives
Still, there is plenty to like even in the currently uncertain environment. Global spending on data center hardware and related management software was about $100 billion a year in 2019. Add in the software services the infrastructure supports, and Gartner said global spending on the cloud industry was somewhere in the ballpark of $228 billion in 2019. While the industry itself will likely move in fits and starts -- especially on the hardware side -- Gartner thinks global cloud spending will exceed $350 billion a year in 2022.
Granted, those predictions were made prior to the pandemic, and Gartner has since said it expects tech spending to decline this year -- offset by an increase in cloud services themselves. It isn't a pretty picture for 2020, but eventually the continual rise in cloud service usage will keep demand for hardware and software like what Arista provides buoyant.
And besides the "cloud titans," spending on smaller data center projects could help Arista in the years ahead. The company is wrapping up year one with its Cognitive Campus service, which helps smaller businesses update their legacy networking with a more modern and simple software-defined approach. As expected, Cognitive Campus is on track to have generated $100 million in revenue in its first year.
It's a solid start, but a small fraction of the $2.34 billion in revenue Arista generated over the last trailing 12 months. However, Arista's CEO Jayshree Ullal pointed out that it took seven years for its cloud business to reach $500 million in sales, and a similar trend could be at play here. Nevertheless, networking is a big market for Arista to crack, and capturing only a little over $2 billion a year in revenue means there's plenty of room for the company to make further inroads.
Though its days of ultra-fast expansion well into the double digits may be over for now, there's still plenty to like about Arista Networks. A networking upgrade cycle will eventually kick in, and growth from helping smaller enterprises update their infrastructure could help soften what could be a rough 2020. Plus, cash and equivalents of $2.64 billion and zero debt could come in handy as the company tries to fire up its growth engine again. The last few years have been nothing to write home about, but the next five could be far more promising.