Friday, October 12, 2012

Aruba Networks and the WLAN Market

There are a lot of things to like about Aruba Networks $ARUN. It is essentially a play on the growth of mobile devices, and in particular, the bring-your-own-device (BYOD) phenomenon in the workplace. These are probably two of the strongest secular trends within IT and they will no doubt continue to be so in future. The question is whether Aruba is fairly priced for this growth.

Four concerns

The recent results were excellent, and the stock continued its strong run. However, I have four concerns with Aruba's latest numbers.

First, they represented a snapback in growth following a lackluster set of results in May. It would be easy to conclude that this just the result of a natural linearity, and that things are actually on the upswing. On the other hand, Aruba’s results can be lumpy. With key verticals in education, healthcare, and government, it strikes me that with these kind of end markets, Aruba’s quarterly revenues can jump around due to project and budget delays. Perhaps the linearity is actually an optic brought about my some deals being moved in to the last quarter?

Second, in the conference call the management mentioned some of its larger competitors being "very price aggressive." In my humble opinion, this group must surely include Cisco Systems $CSCO of which I have an article linked here. As discussed in that article Cisco’s wireless revenues were a standout performer in an otherwise so-so quarter.

Cisco by product line:

As the management pointed out, in its target market Aruba’s customers buy on value and total ownership costs. This is understandable if you envisage a corporation connecting, say, its sales force together via mobile devices. However it means that differentiation is that bit harder to achieve.

I think Cisco’s top three divisions are experiencing slow to negative growth, and it will fight harder with Aruba. In addition, I look at another of Aruba’s competitors such as Hewlett-Packard $HPQ and see a rival that is experiencing structural declines in its core markets of PCs, printers and notebooks. It is sorely in need of some growth outside of its core, and is likely to fight hard to grab market share.

If these two tech behemoths fighting for share isn’t enough, consider that Juniper Networks $JNPR bought Trapeze in order to expand into the WLAN market and it is believed to be strong in the healthcare market; a key vertical for Aruba. Finally, there is privately held Enterasys which merged with Siemens Enterprise Communications in 2008 to become a leading player in WLAN.

The third reason is that the key verticals (healthcare, government and education) are all areas subject to spending scrutiny as a consequence of global austerity measures. It is fine for Aruba to discuss broa- based growth and mention that only Southern Europe was weak (it is a small part of sales), but the truth is that many governments need to scale back plans.  And even in those countries that are growing.

The last reason is that we may well be seeing an unsustainable growth spurt in WLAN and BYOD thanks to the demise of Research In Motion’s $RIMM BlackBerry phone as the default choice of many corporations mobile device needs. A few years ago, the choice was over what model of BlackBerry you preferred. Now, Apple’s iPhone and Samsung’s models are genuine contenders, too. If there is a replacement cycle going on that leads to a growth in BYOD, can it grow at this rate in the future?

I'm not a professional misanthrope, honest

I’ve thrown that subheading in lest someone accuse me of it later! I happen to like the company and the sector, and don’t be surprised if a bidder does, too -- even if it does trade on a forward P/E above 24. I’ve mentioned the competition above, and Cisco could buy Aruba over breakfast. However, anti-competitive concerns might make this impossible. Juniper is a possibility, and even HP might see fit to use its declining cash flow to try and buy its way into some growth.

There is also the little matter of Windows 8 being released later this year. This may well spur investment in mobile devices and release some pent-up spending for the WLAN market to enjoy. Aruba has plenty of upside. However, on balance I think there is a sense that the 52% move up from the June lows has seen the smart money make its returns on this stock. It might be better to wait for a dip before chasing the story higher.