Shares of networking equipment vendor #AristaNetworks ( #ANET ) are up $5.45, or 3%, at $187.17, after #MorganStanley s James Faucette raises his rating on the shares to Overweight from Equal Weight, and jacks his price target to $210 from $125, writing that he’s having to “eat humble pie” about his reservations on the company before. Faucette now believes the company will have a “time to market advantage” because of its software running on its switches, which will help it to capture the 400-gigabit-per-second market from #Cisco Systems ( #CSCO ) and others. Basically, Arista’s going to have a lot more market share and a lot higher margins, than he thought. Faucette now models the company hitting 19% market share in switching in 2020, versus his prior expectations for just 14%, and he thinks operating profit margin can be 32% for the company versus what he had been modeling as 25%. That higher market share already prompts Faucette to raise his estimates for Q3: he sees Arista delivering $415 million and $1.15 per share, up from a prior $370 million and 96-cent estimate. That’s just a little below consensus for $418 million and $1.18 per share. Arista’s operating system has already helped it scoop up share of the 100-gigabit networking switching market: Arista has been developing its software layer to allow for faster time to market since the company's inception in 2004. Most competitors only started to develop similar processor-agnostic software capabilities in ~2012. We think Arista also has cultivated at least some talent advantage. Arista's leadership has proven to be sustainable even as competitors (i.e. CSCO and JNPR) increasingly focus on merchant silicon-based products and large customers invest internally in white box engineering. As 10/40G sales began to transition to the 100G cycle, Arista saw accelerated market share gains, now capturing 26% share of 100G sales vs. mid-teens share of 40G sales. Now, the company’s going to take that same software approach and use it to ride 400G, he thinks: Share gains and growing demand for data center capacity have driven Arista's ROIC above both the hardware and software sectors. We think outsized returns will persist for several returns: 1. Early interest in 400G (although the 100G cycle is still in its first meaningful year) suggests the data center switching market will continue to grow at a healthy rate 2. Arista's time to market advantage is likely repeatable for 400G 3. Continued opportunities to disrupt large adjacent markets (routers, campus switching, optical) with new merchant silicon-based technologies As a result of its competitive advantages, we now expect Arista to achieve 19% share of the data center switching market by 2020 (or 10% of the entire ethernet switching market), up from our previous assumption of around 14%. We expect share gains to be driven by continued wins in data center buildouts likely at the expense of most vendors, but we also note that ~30% of current 100G sales were sales by vendors besides Cisco and Huawei. Arista continues to outperform its operating margin goal of "mid-20s", and we now believe low 30% operating margins is sustainable. Combined with higher share gains, incremental operating leverage in our model lead us to believe that Arista will track to $8 per share earnings by FY20.
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