Akamai (NASDAQ:AKAM) recently announced that it has forged a strategic alliance with Telefonica (NYSE:TEF) to deliver its suite of CDN services to the carrier's enterprise customers. The carrier's international arm, Telefonica Global Solutions, will bundle Akamai's CDN solutions with its own global IP network to sell a portfolio of CDN and telecom solutions to enterprises.  The companies will initially market these services in Spain and Latin America, where Telefonica has the strongest presence, before looking to expand globally from there. It is not clear whether Telefonica will only resell Akamai's services or license its CDN software to run on its network, considering that the carrier already has its own CDN network. But either way, the partnership should help Akamai gain deeper access to the carrier's networks in Spain and Latin America, improving its network efficiency and CDN quality of service (QoS) ahead of the upcoming FIFA World Cup and 2016 Olympic Games.
Mitigates Carrier Threat
The deal follows Akamai's similar agreements with AT&T (NYSE:T) and Orange in 2012, and the more recent acquisition of Edgecast by Verizon (NYSE:VZ). These recent carrier-CDN deals show a growing trend of carriers getting increasingly interested in controlling their own CDNs, as data traffic burgeons due to growing penetration of mobile devices and rising demand for high-quality online video. Historically this was not the case, with carriers generally OK with ceding some of their network control for third-party CDN benefits. Akamai's edge servers installed within an ISP's network helped operators reduce their bandwidth costs as content was cached at the edge and closest to the user, thereby reducing the need to retransmit data every time the user sent a request. Not only did this help enhance user experience but also avoided clogging networks and saved valuable bandwidth for the carriers. Akamai, in return, would get access to millions of subscribers and free network bandwidth.
However, over time, carriers realized that since they own the network, they could develop CDNs of their own and monetize all of the huge video traffic that ply through their pipes. A number of carriers around the world have already started building out their own CDNs, including Verizon and AT&T.  AT&T in 2008 stopped reselling Akamai's CDN service and instead started building out its own CDN. Over time, it licensed Edgecast's software and also restarted its Akamai reselling partnership in a bid to bolster its CDN offerings.  Verizon, on the other hand, has gone the whole way, recently purchasing Edgecast to boost its existing CDN capabilities, potentially ending its reseller partnership with Akamai down the road.
For a long time, Akamai resisted entering the operator CDN market as it would have made it easier for carriers to compete with Akamai for content providers. However, with ISPs increasingly getting serious about their CDN ambitions, Akamai found its value within the carrier networks diminishing. Moreover, smaller competitors such as Edgecast and Limelight were gaining traction with their licensed and managed CDN solutions. So it wouldn't have been long before Akamai found itself competing with the big telcos for market share with hardly any leverage on the carriers. The launch of Aura Network Solutions and the acquisition of Verivue in 2012 showed that Akamai identified the threat and has since been looking to turn potential rivals into partners. Verizon's buyout of Edgecast, a big competitor in the carrier CDN space, could help Akamai in this pursuit, since carriers may be reluctant to license or resell CDN services of a rival carrier.
Gross Margin Benefits
However, more important than the direct revenues of a reselling or licensing partnership are the cost savings and Q0S benefits that Akamai could realize from having direct access to the carrier's network. Akamai has been driving efficiency through its network operations in recent quarters, making investments to lower bandwidth and co-location costs as well as increasing efficiency in content delivery. As a result, Akamai's gross margins have recovered well from the lows of 2011. Last quarter, Akamai saw a 3 percentage point improvement in its gross margins over the same period the prior year as a result of these initiatives. Going forward, we expect the recovery to continue as it realizes the margin benefits of its recent partnerships with AT&T, Orange and Telefonica, as well as more such deals in the future.
Specifically, the Telefonica deal will help Akamai bolster its CDN services in emerging markets in Latin America, where the FIFA World Cup and Olympic Games will be held later this year and in 2016, respectively. Akamai has been at the forefront of the online content distribution of such high-profile global events, supporting NBC's online coverage of the Sochi Winter Olympics last month. NBC Olympics delivered almost 11 million hours of online video, around 80% of which was streamed live through its online portals. Overall, Sochi turned out to to be the most streamed Olympics ever, surpassing even the London Summer Olympics of 2012.  With demand for online video burgeoning, Akamai is pursuing network improvements through such carrier deals so as to be able to efficiently deliver high-volume video content in the coming years.
Disclosure: No positions.