Akamai (NASDAQ:AKAM) recently announced a strong set of Q1 results, beating the high end of its guidance on both revenues and earnings. The company generated revenues of $454 million in the first quarter, about 23% higher than the prior-year quarter when adjusted for the ADS divestment and the recent acquisition of Prolexic. Net income of $0.55 came in at about 4 cents higher than the top-end of guidance. The outperformance was driven by stronger-than-expected media traffic growth, driven by unplanned software downloads and gaming releases. The company also saw strong demand for its value-added services (VAS), especially in website security and app acceleration. The strong revenue growth, as well as efforts to drive network efficiency, helped Akamai post gross margins of 78%, up about 2 percentage points over the same period last year.
However, the Prolexic acquisition is expected to be dilutive to margins in the near term, as the company ramps up investment in sales and marketing to drive long-term revenue growth. Although EBITDA margins in Q1 remained flat y-o-y at 45%, this was partly because the company shifted some of its planned hiring into the next quarter. With sales and other operating expenses set to ramp up over the course of the year, the company expects margins to sequentially decrease to the low 40% range in the near term. After the initial investment phase, Akamai should see its margins improve as additional sales representatives drive revenue growth in the future. Management maintained its long-term EBITDA margin guidance for the company at 40-45%. Our $57 price estimate for Akamai is about in line with the current market price.
Strong Media Performance
Akamai's first quarter saw strong revenue growth across business verticals as well as geographies, despite some macroeconomic concerns in Southern Europe and emerging markets. While online traffic continued to be strong, the strong outperformance was led by some unplanned software releases and gaming patches. The sequential growth was especially promising, given the strong holiday season last quarter and the headwinds from a recent pricing renegotiation with its largest media customer, which kicked into effect from January 1. We estimate that almost 80% of the company's value is driven by e-commerce and media traffic, which continues to surge as mobile devices proliferate and demand for social media, video streaming and online gaming grows at a frenetic pace. Akamai's media delivery business saw its revenues grow by 19% y-o-y and 4% sequentially.
Additionally, user demand for high-quality content, driven by new formats such as 4K and ulta-HD, which require higher bit rates than normal, means that bandwidth requirements are likely to increase significantly in coming years. With adoption of 4G LTE rising in developed markets, and carriers in emerging markets looking to transition to the standard, mobile data usage is also set to surge. According to a recent Cisco VNI report, mobile data traffic grew 81% in 2013 and is expected to grow at a CAGR of over 60% over the next five years (Global Mobile Data Traffic Forecast Update, 2013-2018, Cisco, February 5th, 2014). Akamai, which delivers 15%-30% of all web traffic, stands to benefit hugely from this huge surge in online traffic.
Near-Term Margin Pressure Offset By Product Mix
However, pure-play CDN is rapidly becoming commoditized, with increasing competition from rivals such as Level 3 (NYSE:LVLT), Limelight Networks (NASDAQ:LLNW), Edgecast, and more recently, Amazon (NASDAQ:AMZN). This has heightened CDN pricing pressure in recent years. However, the fact that Akamai has been bolstering its performance and security value-added solutions through new service launches and acquisitions will help it grab a bigger wallet share of customers as well as mitigate the impact of CDN commoditization. These services, which have higher margins than content delivery, have grown to account for almost 60% of Akamai's revenues in recent quarters. Akamai's margins have also benefited from recent network investments, which have lowered bandwidth and co-location costs as well as increased efficiency in content delivery. As a result, Akamai's gross margins have recovered well from the lows of 2011, and we expect the recovery to continue in the near-term as VAS help offset most of the impact of the CDN pricing declines.
Among the various value-added solutions that Akamai sells, security products are seeing the fastest growth. Last quarter, security revenues grew 26% over the same period last year and 3% sequentially. The company's recent acquisition of Prolexic should help bolster sales going forward, as it integrates the acquired technology into its flagship Kona Site Defender and leverages the combined user base to upsell solutions. Excluding Prolexic, Akamai had 867 customers using its security solutions with around 260 on Kona. Prolexic increases that user base by almost a half to 1,250. As part of the integration process, Akamai plans to combine Prolexic and Kona into a single product and extend Prolexic's managed security services to include Kona in the coming months.
Disclosure: No positions.