Higher Spending Could Weigh on Akamai’s Stock

| About: Akamai Technologies, (AKAM)

Akamai (NASDAQ:AKAM) is facing increased competition from newer players like Level 3 (NASDAQ:LVLT), AT&T (NYSE:T) and Limelight (NASDAQ:LLNW) that are investing in their server networks to challenge Akamai’s dominance in the content and media delivery business.

In response, the company is spending heavily to build out its server network in anticipation of continued growth in its core businesses and to fend off new competitors. We expect Akamai’s capital expenditures (capex) to remain at around 23% of gross profits in 2010 and gradually decline to 18% over our forecast period. However, if the capex ratio remains around the current levels in light of mounting competition and margin pressure, there could be 5% downside to AKAM stock based on our estimates, as can be seen in the chart below.

We currently have a Trefis price estimate of $31.11 for Akamai’s stock, about 33% below the current market price of $46.63.

Competition and growing internet traffic demand higher capex

The two recent deals signed between AT&T- Cotendo and Netflix (NASDAQ:NFLX) - Level 3 signal that competition is heating up for Akamai. In an earlier article, we wrote how AT&T’s presence in the enterprise market can challenge Akamai and that newer entrants such as Limelight Networks and Level 3 are targeting the booming area of online video. We also commented on how Netflix’s multi-year deal with Level 3 can impact Akamai’s pricing and revenue per customer.

Akamai is spending heavily on servers primarily in anticipation of higher internet traffic due to increased media content on the internet, an expected rise in HD video leading to greater bandwidth needs and the growth in e-commerce. Though its capex ratio trended down from around 19% in 2006 to around 15% in 2009, it has recently started to rise again on these investmetnts.[1]

The average forecast by the Trefis community predicts that Akamai’s capex ratio will decrease from about 24% in 2010 to about 20% by the end of the Trefis forecast period, compared to the Trefis estimate of a decrease from 23% to 18% during the same period. This implies a potential downside of 5% to the $31.11 Trefis price estimate for Akamai’s stock.

Notes:

  1. Akamai reports capex in its SEC filings

Disclosure: No position