Seeking Alpha
Tech, value, hedge fund manager, telecom
Profile| Send Message|
( followers)  

Akamai Technologies, Inc. (AKAM) is a cyclical growth company that benefits from the low interest rate economic environment. But, the relative performance is mixed. Akamai outperformed the S&P 500 over 10 years, but underperformed over 3 years and outperformed over the past year; I can't draw any conclusions from the historic total return performance.

In terms of the operating ratios, the asset utilization is generally improving. The company is liquid and solvent. There aren't any major legal cases pending. Also, the free cash flow and capital expenditure metrics are bullish for the valuations.

From a business prospective, the business profile is bullish; the company should benefit from the increased use of the Internet. The investment activities are mainly aimed at increasing capacity and improving product offerings. Also, the forecasted return on equity is about 10%. And, the valuations are being boosted by strong historic growth and forecasted growth. Currently, Akamai is fairly valued, but I will accumulate shares in the $36 to $41 zone.

Risks

  • The firm is battling declining prices for its products, which means it has to increase revenue through increased usage of its products.
  • Akamai has to contain its costs, such as co-location expenses and bandwidth expenditure.
  • The competitive environment in technology is fierce and Akamai may face the threat of substitute products.

Business Profile

Akamai provides content delivery and cloud infrastructure services for accelerating and improving the delivery of content and applications over the Internet. Their solutions range from delivery of conventional content on websites, to tools that support the delivery and operation of cloud-based applications, to live and on-demand streaming video capabilities.

The company offers five core solutions: Terra, Aqua, Sola, Kona, and Aura. The Terra solutions are designed to improve the operation of highly-dynamic applications used by enterprises to connect with employees, suppliers, and customers. Aqua solutions are designed to accelerate business-to-customer websites that integrate rich, collaborative content and applications into their online architecture. Akamai's Sola solutions are designed to enable enterprises to execute digital media and software distribution strategies by improving the end-user experience, boosting reliability and scalability and reducing the cost of Internet-related infrastructure. Kona is designed to provide superior cloud computing security, prevent data theft and downtime and mitigate distributed denial of service attacks by extending the security perimeter outside of the data center. Aura Network Solutions is a line of managed and licensed content delivery network [CDN] offerings designed specifically for network operators to build their own CDN capabilities.

Akamai generates just under 30% of its revenues from outside of the U.S. Revenue from Europe is just under 20% of total revenues. The company derives those revenues from the world's leading corporations, including Apple (AAPL), Adobe (ADBE), Audi, Dolce & Gabbana, EMC (EMC), Home Depot (HD), and Microsoft (MSFT). Akamai also derives a portion of its revenues from public sector customers. In recent years, no customer accounted for more than 10% of total revenues.

In terms of competition, the company doesn't mention any specific competitors in its annual report. Generally, Akamai competes with companies offering products and services that address Internet performance problems. Based on the evidence in the competition section of the annual report, Akamai competes with Cisco (CSCO), and Barracuda.

In October 1998, Akamai entered into a license agreement with the Massachusetts Institute of Technology under which it was granted a royalty-free, worldwide right to use and sublicense the intellectual property of MIT under various patent applications and copyrights relating to Internet content delivery technology.

Based on the pricing environment that Akamai's management cites, I believe Akamai is pursuing a low-cost strategy. In a low-cost strategy, companies strive to become low-cost producers and to gain market share by offering their products and services at lower prices than their competition while still making a profit margin sufficient to generate a superior rate of return based on the higher revenues achieved. Further, I believe Akamai is pursing a defensive and offensive low-cost strategy in order to protect and gain market share and increase returns.

Companies seeking to follow low-cost strategies must control costs, operate efficiently and provide appropriate managerial incentives. Additionally, they must commit themselves to scrutinizing production systems and their labor force and to low-cost designs and product distribution. They must be able to invest in productivity-improving capital equipment and to finance that investment at a low cost of capital.

That said, societal changes globally are making the Internet a larger part of our lives. As data transmission continues to increase, Akamai may play an increasingly important role. The number of network connected devices is expected to increase significantly in the coming years. For example, tooth brushes and coffee makers will probably be connected to the Internet within the next 10 years.

Overall, the business profile is bullish for the valuations.

Investing Activities

Besides the usual cash management investing activities, Akamai actively pursued an acquisition strategy and developed internal use software while increasing capacity.

During 2012, the company recorded expenditure of $219.8 million for plant, property and equipment. Capitalization of internal-use software and cash paid for expenditure is reported as $336.7 million.

During 2010, 2011, and 2012, the company substantially increased capacity and made acquisitions aimed at improving product offerings. The investing activities are bullish for the valuations.

Consolidated Forecast and Valuations

Akamai's revenue is increasing in the low double digits. Revenue growth is partly attributable to acquisitions. Also, the firm has a solid operating margin and net income margin, both of which don't vary significantly.

That said, I'm forecasting revenue to increase in 2013 in the 10% to 20% range. That means revenue should be in the $1.51 billion to $1.65 billion range. Operating income should be in the roughly $350 million to $430 million range, and net income should be in the roughly $225 million to $280 million range. I included a 10% percent revenue growth forecast because the company may not make as many, if any, major acquisitions in 2013.

The company has solid margins and an excellent pace of revenue growth. The forecasted fundamentals are bullish for the valuations.

AKAMS&P 500AKAM 5Y Avg*
Price/Earnings34.516.634.1
Price/Book3.32.32.8
Price/Sales5.61.55.7
Price/Cash Flow14.89.916.6

*Price/Cash Flow uses 3-year average.

The short term time series valuation suggest Akamai is fairly valued to modestly overvalued. Relative to the 5-year average valuations, Akamai is fairly valued, but Akamai is overvalued relative to the S&P 500. Thus, Akamai is fairly valued; paying 5.6 times sales, 3.3 times book and 34.5 times earnings for a growth company is fair.

What price range would make Akamai undervalued?

Share Price Forecast & Return on Equity

The share price topped at about $48; so, I will use the $48 level to model share price declines.

Based on my model, I would get involved on the long side somewhere in the $41 to $36 range. In June, the $40 level acted as support.

I forecast a 2013 return on equity of about 10%. That is above the firm's cost of equity. Thus, Akamai should create wealth for shareholders. The evidence suggest being bullish on Akamai.

Source: Akamai: A Story For Internet Bulls