Since 25th July 2012, the stock price of Akamai Technologies, Inc. (AKAM) has risen by 30.55%. If you are curious about what the reason might be, here's a hint: second quarter results FY2012 released on 25th of July!
Revenue for the 2nd quarter of 2012 was $331 million, a 20% increase over 2nd quarter 2011 revenue of $277 million. Revenue growth is the signal of company expansion, which in turn leads to the maximization of shareholder's equity.
GAAP net income for the 2nd quarter of 2012 was $44 million, or $0.24 per diluted share, an 8% decrease from second quarter 2011 GAAP net income of $48 million, or $0.25 per diluted share, and a 2% increase from first quarter 2012 GAAP net income of $43 million, or $0.24 per diluted share.
The net income graph seems to be on an upward move as of yet, which can again be considered a positive signal.
"Akamai's very strong second quarter results were driven on the top line by increased adoption of our cloud infrastructure solutions as well as continued growth of content delivery solutions," said Paul Sagan, President and CEO of Akamai. "Our bottom line performance was the result of significant benefits we have begun to realize from improvements we are making to scale our network operations."
Perhaps, these are the reasons why the stock price of the company improved over 30% in the last 3 months, while Dow Jones Industrial Index fared with an increase of approximately 10%. Wait! Does 30% in the last 3 months seem high to you? How about 74.8% in the last one year? Check the image below:
But the question is whether such a price rise is warranted or not? Do the 2nd quarter financial results really inspire us that much? I don't think so. Although the company shows potential for future growth, let's look at the less obvious yet worth considering factors.
A dig deeper into the company financials
The very first thing that caught my attention was the diminished operating income. Operating income in the 2nd quarter of 2012 fell to $67 million, compared to $71.6 million in the 1st quarter of 2012 and $73.23 million in the 2nd quarter of 2011. Should we be wary of the tanking operating income? Perhaps, no, and the reason is as follows.
While the operating margin of Akamai Technologies still runs at 20.23%, two of its main competitors in the market, Microsoft and Digital River aren't doing that much better either. The last quarterly operating margin of Microsoft (MSFT) and Digital River (DRIV) are 1.06% and 1.09% respectively. In fact, two other companies, Brightcove Inc. and Limelight Networks are already running in the negative. Now, you have tanking operating margin on one end and "comparatively" higher operating results on the other. Akamai Technologies seem to be walking the thin line here.
The sales and marketing costs have shot up to $75.88 million in the 2nd quarter of 2012, compared $67.3 million in the 1st quarter of 2012 and $52.84 million in the 2nd quarter of 2011. Perhaps, this is what works in the tech sector - brand popularity, which leads to new lead generation and customer loyalty. Market presence is what makes you stand out among the smaller players. With hundreds of new tech startups cropping up every day, somewhere in the whole wide world, you got to stay ahead with increasing marketing and acquisition costs. Gobble up the smaller fish and flaunt your size to the world - that's the motto!
Following that motto, Akamai Technologies spent around $291 million in the 1st quarter of 2012. It acquired Cotendo Inc. in March 2012 to strengthen its presence in the content delivery market. Cotendo specializes in software and services that improve the delivery of content across the Web and on mobile-device networks.
And this September, Akamai acquired FastSoft Inc. for an undisclosed cash amount. Needless to say, this will be reported in the 3rd quarter of 2012. The acquisition is expected to complement Akamai's cloud infrastructure solutions with technology for optimizing the throughput of video - and other digital content - across IP networks.
"FastSoft has developed unique acceleration software that is expected to be a strong complement to Akamai," said Bill Wheaton, senior vice president and general manager, Media Division at Akamai. "Their development team possesses extensive experience in advanced TCP technology that we believe can enhance the delivery of rich media, as well as support future initiatives in the areas of mobile applications and cloud performance."
Acquisitions lead to accumulated intangible assets and goodwill. Is this a good thing?
Well, goodwill represents the amount that you pay as a premium over the book value of a company. Though goodwill falls under intangible assets, it is categorized as an unidentifiable asset, which makes it even harder to assess its value. In the balance sheet, the intangible assets including goodwill value increased to $793.7 million in the 2nd quarter of 2012 as opposed to $498.3 million six months back. I can only guess that the Cotendo acquisition might have led to the sudden rise in the intangible assets in this quarter. Did the acquisition warrant such high premium? Doubtful indeed!
Okay, enough talk about the fundamentals of the company.
Is the company overpriced?
To start with, if we look at the price-to-book ratio of Akamai, standing at 3.21, in comparison to 2.83 for Adobe Systems (ADBE), 3.94 for Microsoft and 4.67 for Equinix Inc. (EQIX), we can say it is very much in line with the rest of the industry.
But this metric is pretty vague to be honest. Sometimes, book value only signifies the tangible assets, but as is the case with the tech companies, the intangible assets make for the majority of the amount. So, leaving them out of the equation might not be a good option.
As my Alpha friend, William Meyers, quoted in his article:
"For most investors AKAM has probably reached the point where the high P/E is getting hard to justify, given the other choices in the market."
Even the analysts' estimates show weaker growth expectations in the coming one or two years. The company is expected to grow at a rate of 11.50% next year, compared to the projected industry average of 24.8%. With the growth projection expected to go flatter in the coming few years, the stock price will probably tank down fast from where it has surged today in sudden excitement.
To support my statement, let's look at the graph below (duration: last six months):
If you look at the chart above, the RSI signal of over 60 shows that the stock is clearly overpriced at the moment. Even if the trading price has not reached its peak yet, weakening growth expectations make it hard to go nowhere but downward.
Additionally, the presence of 'dojis' (a candlestick terminology) in the recent trading sessions clearly signifies lack of decision among the investors, which might be the first sign of an upcoming downward slide.
Yet it must be noted that the Bollinger bands do tell a whole different story. The stock price graph continues to break the upper resistance again and again, and doesn't even touch the middle band in the recent times.
And when we look at the MACD graphs, the downward slide of the MACD line, along with the regular bearish crossing over the signal line does indicate that a downward trend might be starting very soon.
Even if the price seems to be going down in the coming few weeks, I am supremely confident that Akamai, with its latest tech acquisitions and streamlining of the business model, will turn out to be a profitable survivor.
And I might be there to catch the next uptrend. What about you?
Additional disclosure: Investing is subject to market risks. Please contact your personal financial adviser before investing.