In today's Oxen Group recap, we will be looking at Akamai Technologies (AKAM) in our daily deeper look as well as General Motors (GM) in our company news section. GM had two interesting news stories break Wednesday with a major hedge fund noting shares could rise 40% or more, while the company sold a stake in Ally Financial. The Oxen Group covers both companies year round, and we want to update our current pricing to reflect recent occurrences. Additionally, as always, we will do our typical market overview, important news breakdown, and give our perspective on what's moving the market.
The markets moved lower on Wednesday, making it four down days in a row. It was a big day for economic data with ADP Employment Change, New Home Sales, ISM Services, and the Fed Beige Book all being released. ADP Employment came in better than expected at 215K versus expectations of 160K. October numbers were revised from 130K to 184K as well. The rise in employment at such a nice level is giving way to more speculation that the Fed will begin to taper in December, and a lot of market participants are selling on that speculation. Additionally, that speculation got help from New Home Sales, which came in better than expected for October at an annualized rate of 444K versus 420K estimates. Further, the Fed Beige Book showed a lot of strength in most regions of the country. All that left traders believing taper will occur and backing off the market.
Today, we are taking a look at Akamai Technologies. Heading into today, we had a Sell-rating on AKAM with a price target of $34. We have not been bullish on AKAM due to the fact that we believe the company lacked a major economic moat, and they have trouble due to competition. Some of that started to play out in the company's latest quarter when the company's guidance came in a bit light
After updating our model, we now have a price target of $39 with Hold rating from Sell, and we will talk about the reasons for this change in the paragraphs to follow.
Akamai operates within the cloud services industry with a focus on security, media delivery solutions, website optimization, classic cloud/server storage, and network solutions. The cloud industry, as we all know, has been undergoing considerable expansion as more and more companies/businesses move services to the Internet and to mobile as well as optimize their business to compete with others.
Additionally, the company is operating in many online retail fields with over 250 retailers that use Akamai for website experience that helps with spikes in traffic, improve performance, guarantees the site will not go down, and protects the buyers with security.
Here are some general industry statistics important for Akamai:
- The IDC believes that cloud network spending will increase 25% in 2014 and account for 89% of all IT spending growth.
- The cloud could produce $100B in sales in 2014 as more data centers come online, as well as an increase in cloud infrastructure services.
- According to some studies, 69% of businesses that have separate budgets for cloud computing believe that they will increase that budget.
- Emerging markets are expected to account for $740B of IT spending in 2014
- Online retail will continue to grow with another 10% jump in 2014 and potentially $250B in sales, making up 8% of the entire industry.
The key catalyst for Akamai right now is the company's economic moat or lack thereof in conjunction with their acquisitions this year. It is difficult to form any economic moats in the software industry. While the software is unique, there tends to be another company that has a very similar product. In every field, AKAM has a competitor; from security to enterprise products to mobile delivery. Yet, this year has been marked by a high number of acquisitions for the company. The company has made two key acquisitions in the past few months with Prolexic and Velocius Networks. Prolexic helps the company in the security area while Velocius works with cloud optimization. We have seen this pattern for AKAM since we started following them. They make smaller acquisitions to help fine tune their product line and continue to expand.
That method has been with them since we started covering them as we wrote in our article back in March:
These small firms that are purchased are intended to preserve and grow the core business. FastSoft, Blaze, and Cotendo were recently purchased by AKAM and looking into what these firms do can give investors a clue into what AKAM plans to do in the future. These small firms that are purchased are intended to preserve and grow the core business. FastSoft, Blaze, and Cotendo were recently purchased by AKAM and looking into what these firms do can give investors a clue into what AKAM plans to do in the future. FastSoft was purchased with a goal of complementing Akamai's cloud infrastructure solutions with technology for optimizing the throughput of video and other digital content across IP networks. AKAM's buy-out of Blaze achieved the goal of complementing Akamai's site acceleration solutions with technology designed to optimize the speed at which a web pages are rendered. Akamai acquired Cotendo to push the pace of innovation in the areas of cloud and mobile optimization. These are all clues into what AKAM wants to preserve in the technology sector from competition. One could argue that AKAM is now growing inorganically, or by acquisition, but as long as AKAM puts up impressive returns on assets (in the neighborhood of 60%) AKAM will be in great shape. The M&A team has historically done a good job performance wise, this increases AKAM's barriers to entry and protects its precious gross margins.
The company's latest acquisitions continue this trend. We are definitely fond of the Prolexic one as it provides a much needed security boost, which the company has signaled as their top growth area moving forward. Prolexic will give AKAM new exposure to large enterprise customers given a stronger security feature. Wells Fargo predicted that the deal could help security grow $100M. That is a big boost to the company.
What we are seeing is a company that is growing through smart acquisitions that can allow them to expand their wide offerings. Instead of being in just one aspect of the cloud, data optimization, and IT revolution, they have their hand in a lot of things. They are also doing these things quite well because they are complementing their products with adding companies that work specifically on one aspect of IT. It is a great way to build a business, and we see no reason for that to stop.
Here is the company's CEO talking about acquisition:
Well, we're looking across all of our areas for acquisition. We always are. Last year, we did close 4 deals. The year before, we didn't do any. We haven't done any yet this year. But we're always looking and we're always working on it in all the major areas, from media to acceleration to security and to hybrid cloud optimization and carrier products, where we made an acquisition at the end of last year. So it's something that's a constant and ongoing effort, and we are disciplined about it. We want to make sure that we buy companies that really -- that we can leverage to add value to our customers.
Overall, we believe that this industry is one that is now constantly shifting and is tough to create an economic moat (just look at F5 Networks). Luckily, AKAM has built a whole family of products with in-house R&D and strength through acquisitions. What we had originally seen as a potential weakness now looks like a strength as a lot of these deals have worked out well.
Right now, AKAM has a 21 future PE, 5.4 price/sales, and 31 price/FCF ratio. It is not a cheap stock, but it is also a growth name. We want to determine whether or not the stock now has value by pricing out the company's potential moving forward.
Revenue - The company reduced Q4 2013 estimates, but they appear to be short-term issues with more volatile inputs around the holiday season as well as a large renegotiation the company is working on with one of its top clients. Still, the company is looking at around 14% growth this year. We would expect something similar again next year as the market continues to expand. From there 2015-2017 are the question marks. The question is what is next for the "third platform" of IT. Will these companies continue to expand at similar rates? We would expect some slowdown to occur in this period as a lot of companies will look to spend less on IT as there has been an IT spending frenzy over the past couple years. A low double-digit, high single-digit growth level should still be expected.
Operating margins - The company has seen operating margins mostly between 23-26%, and this should stay relatively the same. The company has seen operating margins drop in big acquisition years, but we would guess 2014 would likely be moderate in this category. There is not a lot of reason to expect things to move well outside of this range moving forward.
Capex - The company noted that 2013 capex will stay at around 16% of revenue, which is quite high. It has been up in this area and should stay there for 2014. Yet, we would likely begin to see this decline as the growth phase starts to dry up past 2014.
When we use this information in a DCF analysis, we still get a $35 price tag for AKAM in our worst-case scenario. In our best-case scenario, we get $43, putting our price target at $39. That level is still below current valuations. One of the issues that we still see is that the company has a high WACC and even in a best-case scenario, the company is still pricing in a lot of future growth. For us, we would need to see reason to believe 14%+ growth can still happen past 2015, which we do not see at this point.
Today, in our company news section, we will be diving into General Motors. The company was busy on Wednesday with a number of new developments, and we want to take a look at some of them to see how they fit into our model. The company is Hold-rated by us, as we believe that it has made quite a move in the past year and is likely to be less exciting. The company, though, saw two big developments occur Wednesday one day after another auto sales report.
The first big news was Hayman Capital noted that they had taken a stake in the stock, and they followed that up by noting the company had 40% upside in the next 12-18 months. The reason for this is that the company is undervalued in comparison to its industry and the US government is still the largest shareholder and puts a lot of selling pressure on the name. They specifically liked the risk/reward profile in the name. Let's take a look at the first part about it being cheaper than its competition. GM sits with a PE of 16.5, price/sales at 0.4, price/book at 1.9, and price/FCF at 95.3. Ford (F), a favorite of ours, has a PE at 11.7, price/sales at 0.5, price/book at 3.2, and price/FCF at 35.3. Toyota (TM) sits with a 14 PE, 0.8 price/sales, 1.5 price/book, and 44 price/FCF. It is not like GM is really all that much cheaper, and in fact is actually more expensive in many ways.
As for the government, the government's stake in GM will be done in March, and the Treasury Department still has around 100M shares at the last announcement. The shares will all be sold by March. At that time, it is likely GM will reinstate a dividend and potentially do a share buyback. Yet, in our opinion, this knowledge is not unique. The government buyback has been known for some time, and the stock is up 50%+ in the past year. Bass and Hayman are not saying anything new, and the news is more a flash in the pan than anything sustainable in our opinion.
The other major news was that the company has sold its remaining stake in Ally for $900M. This news is actually better because it means that the company gets one step away from the government once again, as they have a large stake in Ally as well. The $900M does bring nice cash infusion into the company, which is a benefit. FCF in the TTM has only been $563M. The $900M could be part of a potential dividend or reinvestment project post-government. Removing this also takes some of the black eye away from the company and helps their overall image. Additionally, it can help potentially pay off $31B in debt the company has.
GM has some bright prospects moving into 2014 with the government off its back, but they are no brighter than the rest of the auto industry. Given that shares are actually a bit more expensive than Ford , we prefer the latter with all things equal. At these levels, we believe the Ally deal is decent news but Bass is stating what has been known for some time. What we need to see is margin expansion from this company, a dividend reinstated, and the debt burden pulled back. Those things would be true catalysts for more upside.
Thursday could be a day for the market to break its losing streak. A late recovery on Wednesday to push almost green could set up for some follow through on Thursday. The key for the day will be GDP for Q3, initial jobless claims, and the continued conversation of whether to taper or not. GDP will obviously play a large role in this as it's expected to come in at 3.0% from the 2.8% prior estimate. Jobless claims have been dropping. The question for the market right now becomes when can good news be good news and not bad news because we lose the Fed. We may be a while off from that, and if news is good, we may taper off again on Thursday. We will see how these reports drive the S&P (SPY) and Dow Jones (DIA) on Thursday.