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Aug 19, 2023

Generative AI Could Sustain Arista Networks’ 31% Annual Stock Growth

A monitor displays Arista Networks Inc. signage on the floor of the New York

A monitor displays Arista Networks Inc. signage on the floor of the New York Stock Exchange (NYSE) ... [+] in New York, U.S., on Friday, Aug. 24, 2018. U.S. stocks rose, while the dollar deepened losses and Treasuries turned higher after the Federal Reserve chair signaled the central bank has no intention of accelerating the pace of rate hikes. Photographer: Michael Nagle/Bloomberg

It's very rare for a founding CEO to stay in place after a company goes public. After enjoying a 31% average annual increase in its stock price since going public in April 2014, it should be no surprise that CEO Jayshree Ullal remains CEO of Arista Networks ANET , the Santa Clara, Calif.-based cloud networking technology provider.

Ullal — Forbes estimated her June 1 real time net worth at $2.5 billion — is among an elite group of founding CEOs who have remained at the helm of a company three years after leading it to an IPO. The leadership skills she wields and the potential for future growth with help from Generative AI bode well for investors.

Generative AI — the technology ChatGPT made famous — is on a roll. On May 25, Nvidia stock soared some 25% after a forecast of much higher than expected revenue in the current quarter thanks to high demand for the designer's powerful graphics processing chips by builders of large language models.

Generative AI will also increase demand for network switches that speed up communications among racks of computer servers. Such switches are essential to hyperscalers — such as Microsoft MSFT , Google, and Meta Platforms META — in a hurry to design and train LLMs.

Arista — whose stock rose by 24% between May 24 and pre-market trading on May 30 — sells such switches to hyperscalers. In 2022, Meta accounted for 26% of Arista's revenue while Microsoft contributed to 15% of Arista revenues last year.

While Arista says it is in the early days for its participation in Generative AI, Morgan Stanley MS sees a significant opportunity for Arista. Analyst Meta Marshall estimated AI networking will be an $8 billion opportunity by 2028 "with Arista being one of the biggest beneficiaries."

Arista is not alone in developing technology for speeding up generative AI. Cisco Systems CSCO and Juniper Networks JNPR provide such networking technology — offering customers proprietary technology

Other vendors offer so-called white box solutions which save money by running bespoke software on commodity hardware rather than expensive, proprietary switches.

Arista intends to provide customers a hybrid approach depending on the type of application. As Ullal told me last month, "We are comfortable with the idea of a white box since that is how we started as software running on everyone else's hardware. We want to provide customers what they need. For less mission-critical applications, they can use white boxes. For specialized applications — such as turnkey healthcare or financial solutions — they need Arista."

Ethernet is a crucial technology for generative AI and the amount of traffic that such networks must carry has exploded. As she told me, "When Bob Metcalfe invented Ethernet in the 1970s, the maximum bandwidth he envisioned was 2.95 megabits per second. now it is over 800 gigabits per second. AI networks are operating at petabyte scale," she said.

Ullal has presided over significant growth since she joined as CEO in September 2008. That is when Arista's client — Lehman Brothers — filed for bankruptcy. Fortunately, the technology Arista supplied Lehman helped other financial institutions survive the financial crisis.

Since then Ullal has adapted to the challenges of scaling the company to an IPO and beyond. She evolved from being very hands-on to setting strategic direction and empowering experts. She has built a culture of low-ego and collaboration on behalf of customer success; develops or acquires new products that customers tell her they need; and enhances Arista's bench strength.

Arista was founded in 2004 with 30 engineers and no revenue. She joined as president and CEO in September 2008.

Lehman Brothers — which went bankrupt in September 2008 — was Arista's client. As she told me in May 2021, "We had built a system for the finance vertical and it helped our other finance customers to survive because we had lower latency — nanoseconds versus milliseconds and a software and stack that was programmable. The economy crashed and the customers loved it."

At Arista, she has built a culture that encourages people to work together to make customers successful. "Our focus is on creating disruptive innovation and creating a happy customer experience. When I was at Cisco I led a $1.5 billion business and joked that it was running me. Here we are growing a platform. We architect how we are leading it. We have nurturing founders and our ongoing leadership works well long term," she told me last month.

Her leadership style has changed as the company has scaled through three phases.

"In the first phase, I was jumping into everything. As we reached $1 billion to $5 billion in revenue, I worked with co-founder and chair Andy Bechtolsheim and co-founder and chief technology officer Ken Duda and the leadership team over 10 years. My role was to look at the strategic direction of the company and to empower experts. In the third phase, as we aim to achieve revenue in the multibillions, I am thinking about Arista's purpose and its platform as we diversify to security and availability," Ullal said.

When a startup is trying to get off the ground, the CEO often feels compelled to get involved in everything. Such centralized control limits a company's ability to reach escape velocity.

At that limit, the company faces a choice. Either the CEO learns how to delegate and empower people or the board replaces the current CEO with a new one who can.

How does Ullal know when to let go? As she said, "I start to see people achieving more and ask them questions. Their answers get me comfortable that they have command. If I poke and they still need help, I continue to coach them. I move away from playing the role of being a mentor and coach."

People who carry Arista's culture are role models. "When it comes to software, our co-founder Ken Duda is passionate about quality. If there is downtime, it costs a customer millions of dollars. We have to make sure the network works. He worries about it and he's the one empowered to make it happen. He would rather apologize for lateness than quality. The field demands merit and excellence. We know our stuff and contribute," Ullal said.

Arista aspires to keep its customers buying. As she said, "We look at our talent, the market potential, and we listen to the customer. They ask us to do more. High performance data switching was number one. Next year, 70% said ‘You should be in the campus.’ We went from routing, to campus, to wide area (Ethernet)."

Arista builds or acquires to add "natural adjacencies" to its product portfolio. An example is security for which the company built "a security network telemetry." When Arista saw it was missing wireless, it made an acquisition.

Arista wants to retain the services of the entrepreneur who founded the companies it acquires. "They should fit with our culture, share our cloud vision, and one plus one should be greater than two. We want to get the entrepreneur to integrate with us and deliver customer solutions," she said.

Ullal feels a fiduciary responsibility to build the next generation of Arista's leaders. "For succession planning, I have one or two candidates internally or externally. It starts with me and others to build bench strength. There are people in their 40s, 50s, and 60s who might want to retire. For the next CEO, we need an operator, someone who can embrace our vision and fit it with their style," she said.

Between 2010 and 2022, Arista revenues grew at an average annual rate of 33%. Since going public in June 2014, Arista stock has increased at an average annual rate of 31%.

That could continue. With the possibility of riding the powerful tailwind of generative AI, the $172 a share 12 month price target, according to MarketWatch — 4% above its June 1 price — strikes me as too modest.