Weekly Update September 1-5
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Arista Networks is a picks and shovel play on the AI gold rush. Cliche as it may be, it’s true. The company’s Ethernet switches enable powerful networking in data centers, among other places. Founded by Andy Bechtolsheim, one of the co-founders of Sun Microsystems and a very early investor in Google, Arista focused on software-defined networking while using cheap silicon from Broadcom. The company’s EOS software allowed them some early wins with large players like Facebook (pre-Meta naming). Now, Arista is a giant in the world of networking switches, only second to Cisco but a true rival in the leading edge of 400/800 GB deployments.
What’s amazing is the company’s 30% revenue growth with 50% FCF margins and 45% EBIT margins. Gross margins are 65% but the capital light nature of outsourcing manufacturing and keeping a lean workforce have led to these insane margins. Return on invested capital is off the charts, at over 70% if you back out excess cash. And returns on incremental invested capital bump up against 100%. Basically, these networking switches are cash cows.
And Nvidia knows this as well. The most valuable company in the world is increasingly bundling its GPUs with its own ethernet networking, dubbed Spectrum-X. This is certainly a risk but the largest cloud players dual source, and not everyone wants to be beholden to Nvidia even more than they already are. Right now, Meta and Microsoft make up about 35% of revenue for Arista so there is certainly customer concentration but that’s the way it is when your customers are cash cows in their own right. At 40x FCF, that’s actually not crazy considering 30% revenue growth and 70% ROIC with excellent management. But I do worry about the customer concentration and Nvidia’s dominance in the data center.