Summary
- Cisco isn't making the most of a new standard in wireless networking technology.
- A young-and-hungry small competitor has already beat Cisco on some key fronts.
- This small cap wireless networking stock may offer upside of 30% or more.
There's no denying Cisco (NASDAQ:CSCO) has earned its title as the current king of the networking world. On the flipside, its size and name doesn't inherently mean Cisco can keep all its competition at bay. One such player is already eating into Cisco's market share, but the advent of a new technology standard is only apt to accelerate this young, hungry organization's penetration of the networking market. And best of all, nobody seems to see this company's - and its stock's - true upside.
The average investor doesn't likely know what "802.11ac" means, even if he or she is using it. The average wifi user will sooner than later appreciate what it means, when he or she doesn't have access to it.
802.11ac is the newest technology used to connect wireless devices like a smartphone or tablet to a wifi network. Introduced in early 2014, it's theoretically three times as fast as the now-obsolete (though still used) 802.11n technology used for years, but the explosion of portable devices and bandwidth usage has forced engineers to create the next generation of wifi infrastructure. The introduction of better and faster wifi connectivity options has also forced wifi access providers to purchase new hardware, which has opened a window of opportunity for a small company named Aruba Networks (NASDAQ:ARUN) to take a bite out of market share once easily owned by Cisco.
Cisco offers 802.11ac networking equipment too, to be clear. Both companies began unveiling their 802.11ac hardware shortly after the "ac" standard was officially adopted by the IEEE Standards Association in January of last year. But, a mid-sized market that wasn't getting the attention it deserved by Cisco - and even a government market that seems to have felt Cisco was getting lazy - has been opting for Aruba Networks hardware more often than most investors may readily realize.
Two specific instances, however, underscore how competitive Aruba is when it comes to its bigger rival.
Example #1: In early December, behavioral healthcare service provider NHS Human Services entered the 802.11ac world with a complete upgrade of its wireless network with Aruba equipment. That's not news in itself; Aruba has won a great deal of mid-tier market business of late. What's telling about the NHS upgrade is that the healthcare service provider previously used a Cisco-driven network.
Example #2: In late October, Aruba Networks became the first networking name to win the United States National Security Agency's FIPS 140-2 certification and the first to be validated under the Common Criteria Wireless LAN Access System Protection Profile. The end result: Government agencies now have the green light to purchase Aruba routers. The credential itself is a big milestone, but more than that, it qualifies Aruba to compete in a market that Cisco had long dominated.
But how exactly has Aruba managed to chip away at Cisco's business? By building a better mousetrap.
It's called ClientMatch, which in simplest terms is a technology that constantly finds the best connection point within a wifi network for an individual user, andseamlessly connects their handheld device to that point. This capability allows users to maximize their potential connectivity speeds by eliminating the so-called "sticky client" problem. More important to investors, ClientMatch is a patented technology.
Better still, in June of last year Aruba published the findings of a head-to-head test of its AP-225 hardware and Cisco's (equivalent) 3702i AP 802.11ac hardware. At a load of sixty clients, Aruba Network routers performed twice as fast as Cisco's.
Given that Aruba performed the test and published the self-serving results, they should be taken with a grain of salt. On the other hand, IT research and consulting firm Gartner posted its unbiased scores of WLAN-only access equipment performance in September of last year, and it awarded Aruba Networks the highest score in a field of fourteen WLAN hardware manufacturers. Cisco was third.
Despite the strong technology that's clearly competitive with Cisco, the last four months haven't been kind to ARUN shareholders. The stock peaked at $23.74 on September 11th, and closed at $17.76 on Friday - a 26% tumble first fueled by profit-taking, but sustained by a pessimistic Q2 view that accompanied Q1's results. Specifically, Aruba improved fiscal Q1's revenue by 29% on a year-over-year basis, and turned in a profit of 26 cents per share, topping estimates for a bottom line of 25 cents. For the second quarter, though, the company projected revenue between $208 and $214 million, and earnings of 26 to 27 cents per share. That range is on the lower end of consensus estimates of $211.6 million in revenue and earnings of 27 cents per share in fiscal Q2. The company's second fiscal quarter ends on January 31st.
While concerning on the surface, the tepid outlook may be the company's effort to low-ball expectations. More relevant to long-term investors, though, the reeled-in outlook for Q2 obscures the real size of the opportunity ARUN offers now that it's garnering new market share with a superior product.
That's not going to be an easy idea to swallow for some patient shareholders who have seen the company's earnings stagnate somewhat since 2008. The fact that shares are trading now right where they were trading in late 2007 doesn't exactly help make the bullish case either. There was an end-goal in mind the whole time though; Aruba Networks has been willing to sacrifice margins in the name of market share, as evidenced by the persistent improvement in revenue.
The missing ingredient since 2008 was a catalyst that wouldn't require Aruba to sacrifice margins - at least not to the degree it was - in order to compete with Cisco. The advent of 802.11ac is that catalyst.
The analyst community already sees it, even if the retail investor community doesn't.
According to data from Thomson Reuters, analysts expect Aruba to grow its 2014 (ending on July 31st) top line of $728.9 million to $863.3 million for the current year to $986.0 million in fiscal 2016. As for earnings, last year's bottom line of 77 cents is projected to reach $1.11 this year and $1.30 next year. That's two years of double-digit growth for the top and bottom lines from a company that rarely misses estimates. And, with a projected 2015 bottom line of $1.11, ARUN is currently trading at a palatable forward-looking P/E of just under 16.0. That P/E against a backdrop of solid projected growth rates leaves the stock plenty of room to grow into its average target price of $23.73by next year, anyway. That's 33% better than the current share price of $17.14.
Bottom line: Aruba Networks is simply one of those companies that's gone overlooked because it's only gradually, quietly stealing business from more prolific players like Cisco. But, with a technology that's just as good as (and arguably better than, with ClientMatch) its competitors - in addition to adeliberate middle-market sales effort that Cisco doesn't put forth - the market will recognize this small company's potential sooner than later. ARUN is an attractive longer-term buy up to the mid-$18's, with appreciation potential up toward analyst targets near $24.
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