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Why Microsoft Is Crucial for Arista Networks

By Herve Blandin - May 10, 2021 at 11:00AM

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The tech giant will keep affecting Arista's performance over the next several years.

Arista Networks (ANET -2.06%) has been growing its core cloud networking business over the last several years, partly thanks to the phenomenal success of its largest customer Microsoft (MSFT -1.39%) with its cloud offering Azure. Despite Arista's efforts to diversify its portfolio, investors should realize the tech giant will remain a critical customer for Arista in the foreseeable future. Here's why.

The largest customer

Cloud computing has revolutionized data centers' networking infrastructures. Entrenched with decades of enterprise legacy solutions, the networking specialists Cisco Systems and Juniper Networks were slow to update their offerings to meet cloud customers' requirements in terms of speed, scale, flexibility, and pricing.

Cloud graphics in a data server room

Image source: Getty Images.

Arista took advantage of that opportunity to establish its footprint with cloud customers thanks to its best-of-breed cloud networking portfolio. As an illustration, the high-growth content delivery network specialist Fastly has chosen Arista's gear to build its network, and Microsoft has been leveraging Arista's solutions to expand its cloud networking infrastructure, Azure.

Considering Azure's phenomenal growth over the last several years, Microsoft has become a significant contributor to Arista's top line, with 23% and 22% of revenue in 2019 and 2020, respectively. 

The company doesn't communicate the performance of individual customers on a quarterly basis. But during the first-quarter earnings call, CEO Jayshree Ullal indicated Microsoft will "continue to be very relevant, very important," which contributed to Arista's impressive first-quarter year-over-year revenue growth of 26.7% to $667.6 million, way above the revenue guidance range of $630 million to $650 million.

A strategic customer

Beyond these short-term strong results, investors should keep an eye on Microsoft over the next several years, as the tech giant is poised to remain a key customer for Arista.

Indeed, Azure's impressive revenue growth -- 50% year over year during the last quarter -- is likely to continue over the long term, given the large and expanding size of the cloud infrastructure market it addresses. According to the research specialist Gartner, that market will grow from $59 billion in 2020 to $107 billion in 2022.

And given Microsoft's strong momentum in that area, management anticipates building 50 to 100 data centers each year for the foreseeable future, which bodes well for Arista as a provider of the network layer of such cloud infrastructures.

In addition, beyond the large contribution to Arista's top line, Microsoft will remain a key customer for a strategic reason. The deployment of the long-awaited upgrade from the 100G to the 400G technology will materialize during the second half of the year.

That technology allows a larger volume of traffic to move across networks, which is crucial for large-scale cloud providers to support the ever-increasing volume of network traffic they must deal with. It's like quadrupling the number of extra lanes on a busy motorway.

So cloud giants will be early adopters of this technology, and Microsoft worked with Arista to validate its 400G solution to interconnect data centers. Thus, Microsoft will most likely leverage Arista's 400G technology, which will represent a key driver for Arista to retain Microsoft as a significant customer over the next several years.

In addition, a successful early foray into the 400G market with Microsoft as a reference customer will also help Arista expand its business with large telecommunication service providers. Indeed, Arista is facing challenges in becoming relevant with such customers because of the legacy footprint of the dominant vendors, such as Cisco and Juniper.

More generally, Arista should leverage its early initiatives with Microsoft in the 400G market to sustain or even grow its important market share in the high-speed data center switching market (16.3% in 2020).

Looking forward

Considering the importance of Microsoft as a large and strategic customer for Arista, investors should pay close attention to Azure's quarterly revenue growth. The guidance on Microsoft's investments in its cloud data centers should also provide a solid hint on Arista's growth potential.

As an illustration, partly thanks to Microsoft's upbeat recent results and ambitious long-term plans for its Azure platform, Arista's management anticipates full-year revenue growth to exceed 15%, which seems realistic. And Arista is likely to keep growing over the next several years with strong execution.

Thus, at somewhat elevated forward price-to-earnings and price-to-sales ratios of 31.3 and 9.0, respectively, Arista's valuation seems fair. So in the context of the lofty valuations of some cloud players, investors looking for exposure to cloud computing at a reasonable price should add Arista to their list of growth stocks to consider for the long term.

Teresa Kersten, an employee of LinkedIn, a Microsoft subsidiary, is a member of The Motley Fool's board of directors. Herve Blandin owns shares of Cisco Systems. The Motley Fool owns shares of and recommends Arista Networks, Fastly, and Microsoft. The Motley Fool recommends Gartner. The Motley Fool has a disclosure policy.

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Stocks Mentioned

Arista Networks, Inc. Stock Quote
Arista Networks, Inc.
$130.00 (-2.06%) $-2.74
Microsoft Corporation Stock Quote
Microsoft Corporation
$286.15 (-1.39%) $-4.02
Cisco Systems, Inc. Stock Quote
Cisco Systems, Inc.
$48.70 (-1.36%) $0.67
Juniper Networks, Inc. Stock Quote
Juniper Networks, Inc.
$29.73 (-1.75%) $0.53
Gartner, Inc. Stock Quote
Gartner, Inc.
$307.98 (-2.23%) $-7.01
Fastly, Inc. Stock Quote
Fastly, Inc.
$10.33 (-7.02%) $0.78

*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.

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