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Panic Grips Arista Networks Stock After Earnings Report

Cloud datacenter pioneer Arista Networks (NYSE:ANET) recently lost a quarter of its value after reporting its third quarter earnings. Wall Street punished the company as it projects slowdown for the next quarter, despite beating earnings estimates by a wide margin, keeping its profitability and having maintained a clean balance sheet.

For the quarter, Arista reported a 16% rise in sales and a 24% increase in profits year over year. The Santa Clara, California-based company reported 31% margin compared to 30% a year earlier. Wall Street appears disappointed beyond learning these numbers, as seven analysts downgraded the stock after the earnings report and others reiterated their previous calls while cutting stock price targets. This downward sentiment sent the company's stock down 24% for the day and as a result the cloud datacenter is down 12% so far this year.

Panic began after Arista told analysts and investors its outlook for the next quarter. The company, which just settled $400 million with Cisco last year, informed Wall Street that it now expects its revenue to be between $540 million and $560 million next quarter, or about 8% lower from its previous year, while having kept its gross profitability projections at par--63% to 65%.

According to Arista, the slowdown was a result of a material reduction in demand from a second cloud Titan. According to Gartner, the world's second largest cloud services provider is Microsoft (NASDAQ:MSFT).

"After we experienced the pause of a specific cloud titan's order in Q2 2019, we were expecting a recovery in second half 2019 for cloud titan spend.

"In fact, Q3 2019 is good evidence of that. However, we were recently informed of a shift in procurement strategy with a material reduction in demand from a second cloud titan, reducing their forecast dramatically from original projections for both Q4 2019 and for calendar 2020."

President and CEO of Arista Networks Jayshree Ullal (source)

Meanwhile, Arista maintains a clean balance sheet with $2.4 billion in cash.

After its massive stock price drop following the earnings release, Arista trades at 21 times forward earnings--a significant 60% plus discount of 52 times earnings average in the past five years. Resorting to Wall Street estimates, Arista shows a potential 15% upside from its closing price of $192 last Friday.

Should Arista deliver on its weaker revenue on the next quarter, the company will still be able to report a 12% rise in its revenue for the full year. Meanwhile, optimism on the company should bounce back as Arista expects Microsoft should have a usual spending pattern in 2020.

Disclosure: Long Arista Networks.

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This article first appeared on GuruFocus.