In filing a major lawsuit against rival networking technology company Arista Networks (ANET) on Friday, Cisco (CSCO) has done some initial damage in what is likely to be a long legal war. Arista shares have taken a huge hit, as they sank another 8% in early trading Monday after losing about 7% on Friday after the lawsuit was announced.
Arista’s share slump is an indication that the investment community is taking the lawsuit seriously. It also indicates that Cisco has won the initial PR battle in the court of public opinion, although Arista will certainly fire back once it has had time to digest the lawsuit.
On Friday, Arista officials said they needed time to respond to the lawsuit but Arista Cofounder and CEO Jayshree Ullal, a former Cisco employee, said she was “disappointed at Cisco’s tactics.”
Wall St. analysts expressed concern about Arista’s legal position, pointing out — as did Cisco — that the networking giant has not filed a major intellectual property lawsuit since 2003, when it sued Chinese company Huawei.
Raymond James Managing Director and communications technology analyst Simon Leopold says this may slow Arista’s momentum. The company has been reporting strong revenue growth after going public in June of this year.
“We have worried that Arista’s success and share gains have stirred Cisco,” wrote Leopold in a research note investors released this morning. “We have observed significant progress in Cisco’s products (e.g., Nexus 9000, use of merchant silicon) and we believe Arista had expected more aggressive pricing from Cisco to defend its share. The lawsuit was not an anticipated tactic. Hence, we worry that Arista’s growth could be slowed or margins pressured.”
Leopold expects a “modest overhang” on Arista shares, not a complete disaster. And that makes sense, considering that public companies sue each other all the time.
Even if Cisco proves to have a legitimate case, technology intellectual property lawsuits are common in Silicon Valley and frequently settled with cash payments. Arista is profitable and has more than $400 million in cash and short-term securities on its balance sheet, so managing the lawsuit should not be a problem.
Leopold estimates that an incremental $1-2 million quarterly legal expense could reduce Arista’s 2015 earnings per share (EPS) by $0.04-0.08.
For context, Leopold points out that Juniper (JNPR) settled a suit filed against Palo Alto Networks (PANW) for $175 million of cash and stock. Brocade (BRCD) won patent and copyright suits against A10 for $170 million after two years.
So for the long term? Expect a lot of PR battles and press releases, lots of lawyerly activity, and eventually some sort of cash settlement. This is going to slow Arista down, which is probably part of Cisco’s strategy, but given the history of technology lawsuits it’s unlikely to jeopardize Arista’s long-term existence.