There has been some concern about Akamai (AKAM) because Verizon (VZ) announced its intent to acquire Edgecast, an Akamai competitor in the Content Delivery Network (CDN), or Internet acceleration, space (See Verizon-Edgecast Deal Poses Pricing And Margins Threat To Akamai). Verizon was partly motivated by AT&T's (T) deal to resell Akamai's content delivery services. In addition, Akamai has new partnerships with IBM (IBM) and Cisco (CSCO) that should ramp substantial revenue over time.
There have been many threats to Akamai's CDN supremacy in the past, and to the extent they drove the stock price down, they just created buying opportunities for investors. Akamai's stock price has been quite volatile over the years, but post the bursting of the Internet stock bubble in 2000 the long-term trend has been up. In the last few years, services other than CDN, notably security for cloud services, have been the main source of revenue growth for Akamai.
In early February Akamai should be releasing Q4 numbers. Guidance is for a typically up Q4 driven by holiday traffic. Revenue is expected between $412 and $430 million, up from $395.8 million in Q3 and $377.9 in Q4 2012. Non-GAAP EPS is expected between $0.49 and $0.53, likely up from $0.50 in Q3, but not up from EPS of $0.54 in Q4 2012.
With non-GAAP EPS not growing substantially from Q4 2012 to Q4 2013, and despite revenue up 9% to 14% if within guidance, it is hard to argue that Akamai is a company seeing spectacular profit growth that would justify a high P/E ratio. However, the main reason EPS is growing less fast than revenue is increased levels of investment in R&D and sales for the non-CDN services. Akamai should resume EPS growth if those up-front investments pay off in substantial revenue increases in 2014 and beyond.
In Q3 media delivery segment revenue was $189 million, showing a 15% y/y growth rate. CDN revenue is largely commoditized at this point. Prices fall steadily, but Internet traffic is still growing fast enough to more than offset pricing changes. Also, CDN customers are likely to become performance and security customers over time as well. Conversations with customers indicate vast quantities of high-quality video is poised to move online over the next few years, at much higher-resolution, high-bandwidth formats. The Fast TCP service was released to speed video delivery. So the CDN segment should continue to grow revenue while showing seasonal variability.
Performance and security revenue was $174 million, up 19% y/y. Service and support revenue was $33 million, up 34% y/y. I think those growth rates show the investments are paying off. Kona Site Defender ended the quarter with about 180 customers, with 40 new in the quarter. Another service that is selling well to new customers is Aqua Ion, which helps customers deal with mobile transactions. Other advanced solutions offered by Akamai are IPv6 Adaption, Mobile Detect and Redirect, and Dynamic Site Accelerator.
I believe Internet security is a strong growth area. The bad guys are out there, and they are clever, as the December Target (TGT) fiasco showed, even if it did target terminals rather than servers. If you want to do business on the Internet you need strong security. Akamai is well positioned to serve a significant portion of the security market.
Management at Akamai is taking the long view. In a response to Q3 margins, management indicated that, while efforts are made to keep margins up, if margins were better than reported they would spend more to drive future growth. That is what long-term investors want to hear from management: don't sacrifice the long run to appease short-term traders.
I believe Akamai will continue to grow revenue and profits. There have been times in the past when I thought Akamai was undervalued and bought shares. Despite my generally long-term outlook, Akamai in the past sometimes became the playground for the momentum crowd, so I sold my stock when I thought it was clearly overvalued, and currently hold none. In the last 2 months of 2013 AKAM was relatively calm, trading in a range between $43.74 and $47.90. On January 7, AKAM closed at $46.68, giving it a market capitalization of $8.4 billion.
Trailing GAAP EPS is $1.55 resulting in a P/E of 30.1, trailing non-GAAP EPS is $1.93, resulting in a P/E of 24.2. But consider too that the cash balance ended at $1.2 billion, with no debt.
My reaction to this picture is that the current price is reasonable. Given history, I would be surprised if there is no more momentum-driven volatility for AKAM. Given my high opinion of Akamai's management and knowledge of technology trends, I think any long-term investor can be happy at the current price or lower. In other words, if you want Alpha buy on the dips, then hold through the short-term volatility and trust the trend will be higher as the years pass.
The next catalyst for a price movement is likely to be Q4 results. Remember that Q4 is seasonally strong, so guidance for Q1 2014 will likely be sequentially down. For instance, Q1 2013 non-GAAP EPS was $0.43, quite a drop from $0.54 in Q4 2012.