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Why This Growth Stock Is One of the Best Ways to Invest in the Future of Data Centers

By Nicholas Rossolillo - Feb 26, 2021 at 7:45AM

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After a two-year slumber, Arista Networks is waking up and ready to go on a tear.

Arista Networks' (ANET -1.79%) stock price started to rally back toward its all-time high late in 2020. After hitting rough patches in 2019 (due to a general slowdown in tech infrastructure construction) and 2020 (due to the pandemic), this data center hardware and software management firm is poised to return to growth mode. Its financial results from the final quarter of 2020 offer investors a hint of what could be in store in 2021, as well as how Arista plans to disrupt the status quo in IT infrastructure in the decade ahead.

A forgettable year ends on a high note

Arista struggled through much of 2020 as the pandemic led many of its customers to tap the brakes on spending, and the slowdown in construction of data centers and their adjacent networking infrastructure carried over from the previous year. As a result, the company reported its first full-year downturn since it became a public concern in 2014.

Metric

2020

2019

Change

Revenue

$2.32 billion

$2.41 billion

(4%)

Adjusted net income

$718 million

$787 million

(9%)

Free cash flow

$720 million

$947 million

(24%)

Data source: Arista Networks.  

Business picked up big time in Q4, though. Revenue and adjusted net income increased 17% and 8%, respectively, as spending on data center and network hardware rallied. CEO Jayshree Ullal said Arista signed a record number of new and million-dollar customers during the period. As a group, cloud titans such as Microsoft and Facebook remain its largest sources of revenue -- 36% of the total -- but that dynamic is changing quickly as a host of smaller organizations are starting to make their own long-deferred IT upgrades. Ullal said Arista has surpassed 7,200 total cumulative customers over the last decade.  

However, the biggest news from the Q4 report regarded the company's financial outlook for 2021. Management expects full-year revenue to increase at least 14% -- including a 22% year-over-year increase in Q1. Stabilizing sales to cloud titans, a growing list of smaller customers, a couple of software acquisitions (more on those below), and the fact that it will soon be lapping 2020's depressed financials all combine to account for the rosy outlook.

An illustrated cloud surrounded by computers, illustrating a data center and cloud computing.

Image source: Getty Images.

Much-needed innovation for data centers and IT infrastructure

But is this return to double-digit percentage growth really sustainable? I think so. As Ullal explained on the earnings conference call, IT infrastructure is reaching an inflection point. Where once an organization's network would be composed of segments that siloed data, the new model they are transitioning to is a "seamless cognitive cloud network that is data-driven."

The changes wrought to our behaviors by the pandemic -- sharp increases in remote work, data traffic, video conferencing, etc. -- have made the shift to this more-modern approach to networking more urgent. With $2.87 billion in cash, equivalents, and investments and zero debt at the end of 2020 (a significant sum given Arista's market cap is just $22 billion), this company is well-positioned to take advantage of the situation.  

For one thing, Arista continues to develop its open architecture hardware for data centers and networking. It recently completed more testing on its 400G equipment and expanded on its portfolio of "Cognitive Campus" hardware for organizations managing diverse environments catering to both remote and on-premises workers. It also launched new security and cloud observability services based on the technologies it acquired through last year's purchases of Awake Security and Big Switch Networks. It is becoming clear that Arista has ambitions about turning itself into a one-stop-shop for all of a data center manager's needs.

High-profit-margin subscription software in particular is something to keep an eye on. Ullal said the company expects cloud-based software to contribute about 25% to revenue going forward, a development that should provide an extra lift to the bottom line as the company rebounds. This could also be a competitive advantage when a business is considering its options for updating infrastructure. Arista offers a suite of hardware and accompanying software to manage it after the fact. Given the hardware upgrade cycle underway and a long-term shift toward software, I think that the stock is reasonably priced at its current price-to-free-cash-flow ratio of 32.

Flush with cash and addressing some of the most pressing needs of organizations in this new cloud era, Arista looks like a top stock to stay invested in for the decade ahead.

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Arista Networks, Inc. Stock Quote
Arista Networks, Inc.
ANET
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