Arista’s Momentum Is Impressive Heading Into 2023; Our Long-Term Thesis Intact

We maintain our $130 fair value estimate for wide-moat Arista Networks after a terrific fourth quarter. Arista beat our expectations soundly in the quarter, but reiterated guidance for 2023 that aligns with our model. Arista’s 2022 was a banner year for sales into cloud customers like Meta Platforms and Microsoft, and the company also showed continued progress encroaching on the adjacent campus market. We see Arista’s broad-based success reflecting its differentiated, software-led approach that in our view creates intangible assets and a wide economic moat. Supply constraints remain a factor into 2023, but we aren’t worried about Arista’s ability to produce good results. We see shares as fairly valued.

Fourth-quarter sales leaped 55% year over year to $1.28 billion, driven by strength in the cloud. Arista’s largest driver is its cloud sales, which rose a whopping 128% in 2022 to make up nearly half the overall top line. Greater spending at Meta and Microsoft—which combined to make up over 40% of sales in 2022—to build out virtual reality and artificial intelligence directly benefit Arista’s sales. All of Arista’s verticals rose in 2022, reflecting broad demand for its hardware and software.

Non-GAAP gross margin of 61% is low for Arista in our view, and displays the continued challenges the firm is having with constrained supply and cost inflation, as well as a higher mix of cloud sales that come at a lower margin. We expect Arista to work off some of its component costs throughout 2023, which combined with our expectations for a softer spending year for cloud providers, drive gross margins sequentially up throughout the year in our model. Despite modest gross margin weakness, Arista’s non-GAAP operating margin of 43% was very impressive to us, and shows the operating leverage in its model. We believe Arista has ample room to invest aggressively in its go-to-market approach in newer markets like campus while maintaining strong operating profitability.