Nvidia Getting Ready to Disrupt theIndustry Standard

Analysts at Wall Street firm Rosenblatt Securities recently downgraded shares of high-flying Arista Networks (ANET -0.25%) all the way from a buy rating with a stock price target of $330 to a sell rating with a price target of $210. The reason cited was rising competition from Nvidia.

To be clear, Arista is a fantastic business, and Nvidia's competition isn't a new development. However, some investors have sold off Arista on fears that mighty Nvidia could indeed steal some of its thunder. But is Nvidia really on the cusp of totally disrupting yet another part of the computing technology industry?

The technology standard Nvidia is "disrupting"

Before discussing why some think Arista is in trouble, let's address the fact the stock is up 58% in the last 12 months and roughly 200% in the last trailing five-year stretch -- even after the last sell-off.

But what of Nvidia's disruption? Arista helps its customers -- big tech companies Microsoft and Meta, as well as specialty enterprise companies like financial service businesses, among many others -- build data centers.

Its rise to fame came at the expense of network hardware giant Cisco. Arista monetizes its work for customers via the sale of its leading open-source Ethernet-based data center switches and routers. Those are the computing units that route and manage the movement of massive amounts of digital data to the various systems inside a data center. Running atop those routers and switches, Arista also develops and sells enterprise software that its customers use for cybersecurity and data center management.

As good as Arista's Ethernet platform may be, the fact that Ethernet is a nonproprietary computing network standard means anyone can design a competitive offering. And a competitive offering is exactly what Nvidia acquired all the way back in 2020 when it purchased a small networking hardware company named Mellanox.

It's become fairly well known that the Mellanox networking platform called InfiniBand has helped send Nvidia into the stratosphere. Turns out, InfiniBand networking solutions are exactly what was needed to connect tens of thousands of Nvidia GPUs to create supercomputers that can train AI models.

But InfiniBand products were only one Mellanox asset. Nvidia also got Mellanox's Spectrum Ethernet systems. The latest generation, called Spectrum-X (announced in May 2023, so again, this isn't exactly new news), boasts some serious performance leaps that make Nvidia a contender against Arista's offering.

Is Arista stock really a sell?

This brewing Ethernet battle is important. While Nvidia dominates the AI training hardware market with InfiniBand, as new AI systems and software come to market, new data center infrastructure will be needed to handle the ongoing operation of this software. Ethernet systems are likely to be a top technology to handle this work, so Nvidia encroaching on Arista's turf is notable.

That said, Arista is hardly helpless. Last summer, it helped form the Ultra Ethernet Consortium (UEC), along with one of its top chip design partners, Broadcom, and others. In addition to pushing the boundaries of what's possible for Ethernet in operating AI and other high-performance software, UEC could eventually yield equipment that does some disrupting of its own with Ethernet systems that could be used for AI training. Nvidia CEO Jensen Huang himself admits that UEC is doing important work.

I believe Arista Networks is going to be just fine in the long term. It already expected a slower year as competition ramps up and its customers digest last year's elevated spending. Management forecast 10% to 12% revenue growth in 2024, down from a 34% growth rate in 2023. It may be a slowdown, but Arista is still holding its own. Shares trade for about 34 times expected current-year earnings per share, a premium price, but this company has earned it with its stellar performance over time.