ARUN

[trebor1221]

Hello David,

I was wondering what you think of Aruba Networks (ARUN)?    It seems over sold to me at this point. Recent gap down a couple weeks ago due to news of preannounced delayed revenues and its impact to earnings. That caused the price to be cut in half from 11 to 5.   

This past Tuesday, on Feb 26, they had the official earnings CC. Didn't seem like there were any surprises.  And the company announced a $10million share buyback, which is a decent chunk of the float according to the numbers on yahoo.  I own shares at an average of $5.15, soley on price, if nothing else.    Today it seemed like it was starting to move back up a little near the close, but perhaps that is the buyback in action......hard to tell.  Your opinion would be much appreciated.

Thanks!

[David Randolph]

Hello David,

I was wondering what you think of Aruba Networks (ARUN)?

I just saw your post trebor1221, when you have a question like this don't hesitate to drop me a private message with the link to the post so maybe I can write some comments sooner.

This is the first time I hear or read about ARUN.

It seems over sold to me at this point. Recent gap down a couple weeks ago due to news of preannounced delayed revenues and its impact to earnings. That caused the price to be cut in half from 11 to 5.

Indeed, ARUN is oversold, but the trend is bearish. If you're going to follow charts I suggest you put more weight on trend indicators than counter-trend indicators, because trends usually persist.

And the company announced a $10million share buyback, which is a decent chunk of the float according to the numbers on yahoo.

Yeah, but the free float doesn't matter much. What matters is the market cap, and that is 80,129,000*$5.39 = $432 M, so the $10 M buyback program doesn't have much relevancy.

ARUN's revenues declined for the 1st time in the latest quarter on a sequential basis, going back 12 quarters and the company was priced for perfection.

Estimates for fiscal 2008 and 2009 were cut severely:



$0.26 EPS expected for fiscal 2009, versus $0.57 expected 30 days ago. The forward p/e is now 20.7, but nobody really knows if ARUN will be profitable or not, since until now higher revenues didn't lead to profitability.

As Warren Buffet wrote in his 2007 letter to Berkshire Hathaway shareholders:

«Now let's move to the gruesome. The worst sort of business is one that grows rapidly, requires significant capital to engender the growth, and then earns little or no money.»

In fiscal 2nd quarter of 2006, for example, ARUN had revenues of $22 M and it lost ($1 M). In this latest quarter it had revenues of $40 M and it lost ($3 M) on a GAAP basis. And revenues don't matter much, just profits.

I don't know much about ARUN's business, but if I were to buy a $432 M market cap company I would want it to have better fundamental metrics than ARUN.

Good luck trebor

[David Randolph]

ARUN has deteriorating fundamentals and is still overpriced in my view, as you can read in the post above. The stock is trading at 88 times estimated EPS of 6 cents for the year ended in July 2008, but I'm not sure the company will be even profitable, as it has been losing money every quarter and revenues had a sequential decline over the latest quarter.

Of course, the stock is down a lot to reflect this fundamental deterioration, but with a $489 M market cap I think it still has a lot to go to the downside.

Technically, after touching resistance given by the 45 days SMA, the stock went down sharply yesterday:



I believe it will break the $4.65 lows and that will generate further selling to the $3.5 - $4 area.

If the stock were to close above the 45 days SMA this trade would be invalid, at least in its time frame.

I should have sold it short yesterday but I just saw it. I expect a better follow up on all stocks of the Watch List to improve entry points in the long run.

But I still feel confident that the stock will continue its downside momentum and we'll have a sharp descending leg right now.

Trading Plan:

SELL ARUN SHORT between $5.25 and $5.35. Don't sell below $5.25. Expect to take profits in the $3.5 - $4 area. Stop loss if the stock is set to close above $6.33.

(note: let me know if you're unable to sell this stock short. It is possible that it is heavily shorted and you can't short. One thing is to be unable to short because there aren't available shares at your brokerage (not your fault), the other is to be unable to short because your brokerage doesn't allow shorting (it happens with most European brokerages). If this latest is your case, I suggest you change to a US online broker, like www.interactivebrokers.com, for example)

[trebor1221]

David,

Also note that Wednesday afternoon a SELL recommendation and price target of $4.50 was issued by Goldman for ARUN, which precipitated that big drop on Thursday.  I don't have a public link to provide.   The reason given was overall pressure on the sector and challenges in competing with Cisco. 

Thanks.

[realcoolhead]

Can not short at interactivebrokers.com

[stock]

ameritrade you can

[David Randolph]

David,

Also note that Wednesday afternoon a SELL recommendation and price target of $4.50 was issued by Goldman for ARUN, which precipitated that big drop on Thursday.  I don't have a public link to provide.   The reason given was overall pressure on the sector and challenges in competing with Cisco. 

Thanks.

Thanks for the information trebor1221

Here's the complete analysis from Goldman Sachs analyst:

«Aruba Networks (ARUN, Sell, $4.50 price target)

Thomas Lee is assuming primary coverage of Aruba Networks from Brantley Thompson, who is moving to the buyside. We are downgrading the stock to Sell from Neutral and reducing our six-month price target to $4.50 from $5. Our six month price target of $4.50 is based on 32.9X our CY2009 GAAP EPS estimate of $0.14. Our multiple is based on a target PEG multiple of 0.9X and a long-term EPS growth rate of 35%.

Although we believe Aruba Networks has a compelling offering and its products may be technically superior to the competition's in certain aspects, we believe Aruba faces considerable amount of risk during an economic downturn. Specifically, in addition to slowing end-market demand, we believe that customers could increasingly choose Cisco over Aruba, given Cisco's attractive bundled pricing and the perceived higher risk of going with a smaller vendor during uncertain economic times.

Investment view

• Large enterprise exposure poses significant risk in current environment; we expect next several quarters to be challenging. In our recent survey, CIOs appear to be increasingly bearish on the current macro outlook, and we expect this to have a tightening effect on IT budgets, at least in the first half of the year. This clearly weighed on Aruba's recent results, when the company missed its original revenue guidance for 2QFY08 (January 2008) by roughly 20% (negatively pre announced on February 7). The company cited weakness in certain verticals in both the US (federal and retail) and Europe (retail). Although the company believes the federal vertical is likely to return to normal levels in 3QFY08 as weakness was driven by a delay in spending, we believe that it is likely that enterprise weakness will continue for several
quarters.

• Longer-term concern: Macro slowdown could pave the way for share gains by Cisco. On its earnings call, Cisco talked about being opportunistic in gaining share in certain markets during a potential economic slowdown. During the last economic downturn in 2001-2003, Cisco used its leading position to gain significant share in areas such as Ethernet switching. For instance, from 2000 to 2003, Cisco gained almost 800 bp of revenue share in Ethernet switching, largely at the expense of 3COM (lost 140 bp), Alcatel Lucent (lost 70 bp), Extreme (lost 85 bp), and Nortel (lost almost 400 bp). In the current slowdown, we believe Cisco could offer enterprises attractive bundling packages, essentially giving away its WLAN portion, which would make the
competitive environment more challenging for Aruba. In addition, we believe that during uncertain economic times, IT managers are less likely to choose the solution of a small vendor over that of an established partner that they can have greater confidence will support the product for many years.

• Product offering, while compelling, may not be enough to sway enterprises to choose Aruba over Cisco. Although Aruba has an attractive solution (strong centralized management and security feature set) from a pure WLAN standpoint, Cisco's ability to provide a complete end-to-end solution (integrating security, wireless, VPN, VoIP, routing, and switching), gives it a significant advantage over its competitors. This is particularly the case for enterprises where WLAN is only a portion of the overall networking solution. On the positive front, we believe that Aruba is gaining share from Motorola's Symbol business, given its superior software and security technology.

Valuation

We are lowering our six-month price target of $4.50 (from $5), which is based on 32.9X our
CY2009 GAAP EPS estimate of $0.14. Our target P/E is based on a PEG multiple of 0.9X
(low end of range in our coverage universe) and a long-term EPS growth rate of 35%. This
robust growth expectation is driven by roughly 20% market growth, as well as significant
operating margin expansion from our 5% estimate in CY2009 into the double-digits, as Aruba grows its revenue base and improves its channel leverage. Aruba's current CY2009E multiple of 41.7X represents a 102% premium to the median growth company P/E in our group of 20.6X, and a 156% premium to S&P 500 P/E of 16.3X.

Risks

Risks include (1) a less severe IT spending environment than we expect; (2) lack of increased competitive pressure from Cisco; and (3) successful implementation of Aruba Networks' 2-tier distribution system, resulting in greater-than-expected share gains and operating margin expansion.

Estimate changes

We are transitioning to GAAP EPS estimates as our primary valuation metric. GAAP estimates for Aruba differ from pro-forma estimates primarily in that they exclude share based compensation, net of tax. We believe that Consensus estimates for Aruba are currently pro forma, so we have shown changes to both our GAAP and pro forma estimates in Exhibit 20 for comparison purposes.

Can not short at interactivebrokers.com

Hmm, this is bad, I thought IB had this one for shorting, since it is reasonably liquid.

ameritrade you can

This is good.

It's hard to know which stocks can be sold short at most brokers and which can't. Maybe I should stick just to Russel 1,000 stocks (the largest 1,000 companies in the US) for shorting purposes.

Well, the trading plan is already in march and it has to run its course now:

Expect to take profits in the $3.5 - $4 area. Stop loss if the stock is set to close above $6.14.

(the 45 days SMA is rapidly declining, so the stop loss trigger (on close) is going down by the day).

[David Randolph]

Trading Plan:

Expect to take profits in the $3.5 - $4 range. Buy to cover if the stock is set to close above $5.95.

[David Randolph]

Trading Plan:

Expect to take profits in the $3.5 - $4 range. Buy to cover if the stock is set to close above $5.86.

[David Randolph]

ARUN touched the 45 days SMA resistance and (again) had a negative reaction.

Trading Plan:

Expect to take profits in the $3.5 - $4 range. Buy to cover if the stock is set to close above $5.74.

[David Randolph]

JP Morgan downgraded ARUN to underweight:

We are downgrading our rating on Aruba to Underweight from Neutral as we believe extending sales cycles and shrinking order sizes could continue to plague Aruba throughout 08 – especially in the retailing vertical – since the economic downturn appears longer than we previously expected. And as Aruba invests to expand internationally and to develop its 2-tier distribution system through partner training, we believe it could take longer to achieve its 19-20% LT op margin target. So despite Aruba having emerged as a #2 WLAN player to Cisco, we rate the stock Underweight.

• We expect elongated sales cycles and shrinking order sizes to plague Aruba through much of 08, matching comments from Riverbed last week, and resulting in an increased probability of future earnings misses.

• Lowering our 08 growth forecast for the dependent WLAN market 5 points to 28%, down from our previous estimate of 33% as we believe WLAN deployments are among the more discretionary IT projects, implying that 802.11n roll-outs could be delayed until 2009.

• On the flip side, Aruba appears to be gaining more share – an addt'l point in each of the last two qtrs – however, a new crop of WLAN startups could make it difficult for ARUN to gain share going forward.

• We are lowering our FQ308 revenue and EPS estimates to $41.7M and ($0.02) from $42.6M and ($0.01), the low end of guidance.

• Lowering FY08 and FY09 revenue ests to $174M and $220M from $177M and $235M on our lower market forecast, as our EPS estimates fall to $0.05 and $0.16 from $0.07 and $0.23, all ex-stock comp.

• Aruba trades at 23.9x our CY09 EPS estimate of $0.22 (ex-stock comp), a premium to its peer group average of 12.4x.

The Trading Plan obviously stays the same:

Expect to take profits in the $3.5 - $4 range. Buy to cover if the stock is set to close above $5.74.

[David Randolph]

The Trading Plan is:

Expect to take profits in the $3.5 - $4 range. Buy to cover if the stock is set to close above $5.67.

[David Randolph]

The Trading Plan is:

Take profits at $3.75. Buy to cover if the stock is set to close above $5.54.

[David Randolph]

Trading Plan:

Take profits at $3.75. Buy to cover if the stock is set to close above $5.42.

[David Randolph]

Damn ARUN is touching the 45 days SMA too many times over a short period of time. I guess these rallies happen because of the foundation of the bears case, which essentially relies on a weak US economy or even a recession in 2008.

Every time the general market looks a bit stronger (like yesterday), shorts cover ARUN and bottom fishers show up. The chart shows what seems to be a cheap stock, but if we compare the market cap with the fundamentals and the valuation, the stock is still very expensive by any metric.

Anyway, we're at a crucial point now. The bad news coming from GE need to kill ARUN for good (as it is killing the general market at today's open, making it break down below the short term ascending trendline).

If not, I'll be forced to buy to cover, respecting the following plan:

Take profits at $3.75. Buy to cover if the stock is set to close above $5.33.