Aruba Networks Inc. (ARUN) - VC distributions present opportunity
As urban sprawl crates more traffic jams, higher gas prices increase costs of commutes, and the globalization of business creates a geographically diverse workforce; companies are scrambling to adapt technology to meet these dynamic needs. One of the main challenges that IT departments face is securing sensitive information while still allowing key employees to have use of network resources outside of the traditional brick and mortar office. Aruba Networks (ARUN) is recognized as one of the leading players in the fragmented enterprise wireless LAN sector holding a 10% plus market share. The company’s products and support help to address the necessity of a mobile and fragmented workforce in an era of vulnerable data and increased need for security.
Aruba listed its shares in March of this year with an offering price of $11.00. The deal was warmly received by Wall Street which initially bid the price up to 14 (a 27% initial gain). After consolidating at this level for about 2 months, the stock was bid up to as high as 24 before falling under pressure this fall. It appears the majority of the stock weakness is due to the lockup period expiring after the IPO. Currently there are three major venture capital (VC) firms which owned 51% of the outstanding shares. As the shares became available to trade, the VC firms have begun distributing the shares to their limited partners who have in turn likely been selling the stock to realize their gains. While the fundamentals of the company continue to be attractive, the stock itself has traded much lower due to the supply hitting the market. It appears the VC firms still hold about 42% of the shares which could continue to weigh on the stock price, but the level is now very attractive given the earnings power of the company.
While Aruba has posted negative earnings each year up to this point, The company should earn $0.24 per share in the fiscal year ending July 2008. Analysts have estimated earnings of $0.58 in the year ending July of 2009 which is only 20 months away. This means that the company is trading at a 26 multiple based on next years forward earnings which is a very attractive price for a firm growing sales and earnings at such a robust clip.
Browsing through the company’s most recent quarterly report, it appears that management has done a good job of diversifying its customer base. The press release noted strength in sales to the Education, Government, and Healthcare sectors, but also noted that no single vertical category accounts for more than 20% of revenue. The company is very proud of its all-star customer list which includes the US Air Force, Microsoft, SAP, Google, Ebay, the Ohio State University and more. Diversification of the customer base will help produce better stability as the company does not have to rely on specific areas of the economy to be strong.
When the company priced its IPO, it collected $91.8m from the proceeds. Because the company carries no debt, the funds were able to be applied directly to working capital giving the firm access to necessary cash from which to conduct valuable research and development, fund marketing endeavors, and manufacture sufficient inventory to meet customer demands. While Aruba uses several suppliers of components for their hardware, they have a special agreement with Alcatel-Lucent which gives them a level of credibility with CIO’s in large corporations. ARUN uses Flextronics to manufacture most of its finished hardware as this is a more efficient and cost effective arrangement.
I believe that the recent weakness presents a buying opportunity for the shares as long as investors are willing to put up with a bit of volatility for the next several months. It is likely that the shares will come under pressure whenever VC firms announce a new distribution, but I believe we may have already put in a floor as the market has priced in expectations that these shares will be distributed. In 12 to 18 months, if the company is executing well on its growth plans, the multiple will likely appear very low at this price point and I expect the stock to earn a much richer valuation.
FD: Author does not have a position in ARUN
Here is a letter I recently wrote to Thomas Lee, the analyst at Goldman Sachs, who just downgraded ARUN to a “sell” when it was at $6 aq share…
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Dear Mr. Lee:
Your recent downgrade or ARUN to a “sell” is probably the most irresponsible and poorly supported analyst recommendation that I have witnessed in my investing career. You just now took over responsibility for ARUN and have not even had any time to do any legitimate analysis of the company, its technology, strategy or forecasts, nor have had the time to have thorough discussions with its management. And your rationale that businesses will now shift their procurements to Cisco and away from the number two player in the market because we are in an economic downturn is baseless.
That same logic would predict that when I go to a Best Buy to purchase a wireless router, I will now automatically buy a Linksys router over a Netgear router because we are in an economic downturn, and I want to make sure that if I need to call customer service, someone is actually there to pick up the phone and that the company has not gone out of business, and to be sure of that, I will only purchase from the number one market share holder. Ridiculous.
You reason that because we are in an economic downturn, the majority of all customers will flock to the predominant, largest vendor, severely crippling all other competitors. How absurd. Your second point that customers will also want to package or bundle their procurements together is equally ludicrous. Do you even have any concept of the price, technology, and support advantages that Aruba offers over Cisco? Why do you think Aruba is even in business and why other competitors to Cisco are in business?
Aruba stock was at $22 a share a few months ago. It was around $6 a share when you made your “sell” recommendation, saying you expect it to go down to $4 a share. The only reason it has gone down at all is because of the fact that “Goldman Sachs” has issued a sell recommendation on the stock. When the next quarters results are announced, I am confident the price will go up, as it will every subsequent quarter this year….
I will write you again after next quarter’s results and we will see who has a better grasp on reality, and who is better at your job; you or me. Until then, I suggest you do a little more thorough research on the companies you make recommendations on.
Regards,
Clark Cochran
March 27th, 2008 at 10:54 am