Although Aruba Networks' (Nasdaq:ARUN) fiscal third quarter report in May was disappointing (particularly from a guidance standpoint), I liked the stock on a GARP basis. Oddly enough, while this summer has not been a good one for tech companies, the stock has been quite strong over the past three months. While I continue to like the company, I do wonder if Aruba needs to start showing a little more competitive share growth for the stock to continue working well into the future.

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Closing the Year on a Solid Note
While management's guidance established a lower bar, Aruba nevertheless delivered a pretty respectable fiscal Q4 result. What's more, with guidance looking stable-to-better, Aruba may be pointing to either a general recovering in tech spending or some company-specific momentum.

Revenue rose 22% from last year and 6% from the fiscal Q3, helped in large part by a 14% sequential improvement in U.S. sales. Profitability was also pretty solid, as gross margin improved about three points from last year and almost a point and a half from the prior quarter. On a GAAP operating basis, the company reversed a year-ago loss and posted a better than 60% sequential improvement, though from a very small base.

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Can Aruba Separate Itself?
If there was a disappointment to Aruba's report, it was that the company doesn't seem to be gaining on market leader Cisco (Nasdaq:CSCO). With Cisco reporting basically the same growth in its WLAN business, it seems like Aruba's technological advantages aren't enough to grab away business. At the same time, management cited "aggressive competition" from large companies this quarter. To me, that suggests that Cisco, Hewlett-Packard (NYSE:HPQ) and/or Alcatel-Lucent (NYSE:ALU) may be looking more to bundling and discounting to keep share.

The question I have is whether Aruba's management can leverage what is supposedly better technology into a durable advantage and meaningful market share. Gartner's recently released "magic quadrant" for WLAN infrastructure put Aruba, Cisco and HP all in the top right square ("visionary"/"leader"). Unfortunately for Aruba, while that puts them ahead of Alcatel-Lucent, Motorola Solutions (NYSE:MSI) and Meru Networks (Nasdaq:MERU), Gartner did still place them below market-leading Cisco. That comes despite testing results that show better network performance and controller failover, so Aruba still has a marketing job to do.

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Familiar Themes Still Relevant
The good news for Aruba, even if it's a bit stale and almost cliché at this point, is that enterprise wireless demand usage continues to increase. Should the new ultrabooks and Windows-based phones and tablets take off, that demand should compliment existing demand for Apple (Nasdaq:AAPL) and Samsung products and lead to even more enterprise WLAN spending. That said, Aruba isn't an exclusive play on this theme - companies like Cisco and even F5 Networks (Nasdaq:FFIV) stand to gain from many of these same factors.

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The Bottom Line
Back in May, I thought the risk/benefit analysis favored owning Aruba Networks, even though tech ownership in the summer months can be tricky. With the stock up strongly since then, I'm not quite as excited about it as before. I still like Aruba's technology and market opportunity, and I still think there's a reasonable argument that Aruba should draw an M&A bid at some point. That said, you can't talk about market or stock returns without also incorporating the risk. While I've moved my fair value on Aruba into the low $20s (on the basis of a mid-teens long-term free cash flow growth assumption), that suggests less than 25% upside at today's price. That's enough to make Aruba a worthwhile hold, but I think there are other, cheaper, tech stocks out there that would make for better purchases today.

At the time of writing, Stephen D. Simpson did not own shares in any of the companies mentioned in this article.

Tickers in this Article: ARUN, CSCO, MSI, ALU, HPQ, MERU, AAPL, FFIV

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