800-Gigabit Ethernet Upgrade Will Advance AI Clusters

Key Takeaways

• Transition to 800-gigabit Ethernet for AI clusters could boost revenue, capitalizing on AI-driven data center demands.
  
• Strategic expansion in network adjacencies, global campuses, and cognitive AI could improve growth and margins.
  
• Dependence on specific AI clusters poses revenue risk, while margin pressures and international challenges highlight competitive threats and potential earnings volatility.

Catalysts

Engages in the development, marketing, and sale of data-driven, client to cloud networking solutions for AI, data center, campus, and routing environments in the Americas, Europe, the Middle East, Africa, and the Asia-Pacific.

• Arista's transition to 800-gigabit Ethernet in 2025 for AI back-end clusters could lead to increased revenue as they aim to capitalize on the growing demand for high-speed data center networks driven by AI initiatives.
  
• The strategic focus on expanding their network adjacencies market, which includes routing and cognitive AI-driven campuses, is expected to enhance their revenue from approximately 18% of total revenues, potentially improving margins through higher-value offerings.
  
• Arista's commitment to achieving a revenue goal of $1.5 billion from AI centers, including $750 million from AI back-end clusters in 2025, sets expectations for accelerated growth in a high-margin segment, potentially boosting overall earnings.
  
• The company's focus on maintaining a robust deferred revenue balance, which increased significantly due to customer trials and acceptance clauses, indicates a steady revenue stream and improved cash flow management in future quarters.
  
• There is notable growth potential from global expansion and campus networking, where lead times are improving, and Arista's differentiated strategy may support revenue growth and margin improvements in the long term.

Arista Networks Future Earnings and Revenue Growth

Assumptions

• This narrative explores a more pessimistic perspective on Arista Networks compared to the consensus, based on a Fair Value that aligns with the bearish cohort of analysts.
• The bearish analysts are assuming Arista Networks's revenue will grow by 13.9% annually over the next 3 years.
• The bearish analysts assume that profit margins will shrink from 40.7% today to 37.2% in 3 years time.
• The bearish analysts expect earnings to reach $3.9 billion (and earnings per share of $2.98) by about April 2028, up from $2.9 billion today. The analysts are largely in agreement about this estimate.
• In order for the above numbers to justify the price target of the more bearish analyst cohort, the company would need to trade at a PE ratio of 35.8x on those 2028 earnings, up from 31.8x today. This future PE is greater than the current PE for the US Communications industry at 24.8x.
• Analysts expect the number of shares outstanding to grow by 0.61% per year for the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 6.9%, as per the Simply Wall St company report.

Arista Networks Future Earnings Per Share Growth

Risks

• The reliance on specific AI clusters and customers, such as the stalled fifth cluster awaiting GPUs and funding, poses a risk to revenue growth if similar issues arise with other customers.
  
• Margin pressures are anticipated due to the evolving mix in AI and cloud markets, which could lead to reduced net margins if the increasing demand leads to lower cost structures and higher tariff absorption.
  
• International revenue growth challenges noted by the decrease in international contributions hint at potential risks to Arista's revenue stream if domestic markets face slowdowns or increased competition.
  
• The notable presence of white box vendors as competition suggests a threat to revenue growth, especially if these options gain traction among customers seeking more cost-effective or flexible solutions.
  
• The deferred revenue growth with varying quarterly outcomes points to potential earnings volatility, particularly if customer-specific contract clauses and acceptance trials continue to impact revenue recognition unpredictably.

Valuation

• The assumed bearish price target for Arista Networks is $88.08, which represents one standard deviation below the consensus price target of $109.24. This valuation is based on what can be assumed as the expectations of Arista Networks's future earnings growth, profit margins and other risk factors from analysts on the more bearish end of the spectrum.
  
• However, there is a degree of disagreement amongst analysts, with the most bullish reporting a price target of $145.0, and the most bearish reporting a price target of just $73.0.
  
• In order for you to agree with the bearish analysts, you'd need to believe that by 2028, revenues will be $10.4 billion, earnings will come to $3.9 billion, and it would be trading on a PE ratio of 35.8x, assuming you use a discount rate of 6.9%.
  
• Given the current share price of $71.87, the bearish analyst price target of $88.08 is 18.4% higher.
  
• We always encourage you to reach your own conclusions though. So sense check these analyst numbers against your own assumptions and expectations based on your understanding of the business and what you believe is probable.