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Why Arista Networks Inc. Stock Dropped on Friday

By Anders Bylund - Sep 11, 2015 at 2:21PM

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2:20 p.m. ET: In an important patent case before the International Trade Commission, Cisco Systems appears to be getting the better of Arista. ANET shares are down 10.3%.

What's happening: Shares of cloud networking specialist Arista Networks (ANET -3.25%) fell as much as 12% on Friday, following news on Thursday night that a patent infringement dispute with Cisco Systems (CSCO 0.08%) isn't going Arista's way. At 2:20 p.m., the stock was down 10.3%.

Why it's happening: Staff recommendations from the International Trade Committee's research department leans in favor of Cisco on three of the five patent infringement claims under investigation, and all five of Cisco's patents are said to be enforceable. These recommendations often set the tone for the ITC judge's final recommendations, so it's a big setback for Arista.

If these claims hold up, many of Arista's network switches could be blocked from import into the United States. To put that threat into perspective, 78% of Arista's revenues were collected from American customers in fiscal year 2014.

Arista's engineers and legal advisors are undoubtedly hard at work inventing workarounds for this critical threat. If the company can't come up with alternative ways to make its network switches do their job without stepping on Cisco's patent-covered toes, a very large portion of the company's sales would be in danger.

Although we don't believe in timing the market or panicking over market movements, we do like to keep an eye on big changes -- just in case they're material to our investing thesis.

The companies are fighting over a total of 12 Cisco patents, allegedly used by Arista's high-speed network switches without a proper Cisco license. Some of the claims have been dismissed in earlier decisions, but at least the five patents in front of the ITC this week live on. In Cisco's view, these patented features were brought over to Arista when former Cisco workers took new, high-ranking jobs at the smaller networking expert.

According to Cisco, they are not industry standards but important and unique innovations. Examples include a way to bundle multiple network links into one high-speed data stream, methods to upgrade switching software without interrupting the service, and a database that keeps an eye on the entire system's operations.

Arista shares now trade very close to 52-week lows, weighed down by these legal troubles but supported by an as yet unbroken string of impressive quarterly reports. The company went public in June 2014, and has exceeded Wall Street's consensus estimates on both the top and bottom lines in each of its five quarterly results releases.

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Stocks Mentioned

Cisco Systems, Inc. Stock Quote
Cisco Systems, Inc.
CSCO
$43.38 (0.08%) $0.04
Arista Networks, Inc. Stock Quote
Arista Networks, Inc.
ANET
$98.97 (-3.25%) $-3.33

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