Naveen Selvaraj's  Instablog

Akamai Technologies,Inc(Nasdaq: AKAM) reported second quarter(2Q09) results which were well short of expectations.


Source: Gridstone Research

Clearly, the markets are not happy with the sequential revenue decline( the second consecutive decline at that) of 2.7% to $205M. But Akamai has made it clear in their earnings call that aggressive pricing was a key factor in the revenue decline. The management argues that it is more focussed on increasing the customer base and will pursue an aggressive price strategy to win clients.

So is that good or bad? When we compare Akamai's financial performance in recent quarters with a direct competitor, LimeLight Networks(Nasdaq:LLNW), I would conclude that it is a sound strategy(given the economic situation) which will keep Akamai's long-term growth potential intact. So here are the comps(LLNW has not reported Jun09 results and so the comps are more from a long-term perspective over last two years):

Revenue Comparison - AKAM Vs LLNW


Source: Gridstone Research

LLNW is still much smaller than Akamai despite its aggressive customer acquisition in 2007-08. AkAM did go slow in 2008 saying that it would focus on acquiring large clients which generated more profits rather than focus purely on net customer adds. However that strategy seems to have changed over the last two quarters due to the squeeze in client spending.

Customer Base - AKAM Vs LLNW


Source: Gridstone Research

As the chart below shows, LLNW grew its customer base at more than double the pace of AKAM in 2007 and 2008. But as the higher base effect came into play and the downturn worked its way to impact spending on CDN(content delivery network)
services, LLNW has fared no better than AKAM. My guess would be that LLNW would grow at the same rate(in customer count) as AKAM in the Jun09 qtr.

Customer Base Growth(YoY %) - AKAM Vs LLNW

Source: Gridstone Research

 But look at how the customer growth has NOT translated into better revenue growth for LLNW in comparison to AKAM. In fact YOY top-line growth for AKAM has been better than LLNW in Mar09 quarter despite customer growth rates being more or less same.

Revenue Growth % - AKAM Vs LLNW

Source: Gridstone Research

This is bad news for LLNW than AKAM because while Akamai churns out operating profits consistenly, LLNW is yet to achieve operating break-even.(Mar09 has a one time gain from reversal of litigation provision of $65M)

Operating Profits($M)- AKAM Vs LLNW

Source: Gridstone Research

Even at the adjusted EBITDA(excludes one-offs, stock compensation etc) level, AKAM has been a more consistent performer. The EBITDA comparisons makes it clear that any further price erosion will seriously dent LLNW's profit potential this fiscal and probably the next too.

Adjusted EBITDA($M) - AKAM Vs LLNW

Source: Gridstone Research

AKAM has had a minor dip in EBITDA over the last two quarters but its profitability is less vulnerable than LLNW to pricing pressures thanks to its sheer size. If push comes to shove, AKAM can price LLNW out of the market and gain more customers. This could prove beneficial in the long-run as incremental capex costs come down on a higher customer base, AkAM should be able to improve its margins and operating profits. Also we need to bear in mind that AKAM has a higher 'Capital Intensity' Ratio(capital assets increase for every revenue $ earned) than LLNW. Though this would eat into short-term profits, AKAM should gain in the long-term due to better service levels as a result of this spending and also be in a better position to take advantage of an upswing in client spending. Despite this, AKAM generates better profit margins than LLNW even now.

Capital Intensity- AKAM Vs LLNW


Source: Gridstone Research

In summary, it is premature to be bearish of AKAM's long-term growth story and ability to generate more profits. As some competitors like LLNW and Level3 Communications(Nasdaq:LVLT) report results in the coming weeks, investors would get a better idea of whether AKAM stands out among peers or has lost its edge. In my opinion, Akamai's growth story remains intact and it will perform better than competition in the coming quarters thanks to its market leadership and ability to adapt to changing business conditions and it has demonstrated this ability in the just concluded Jun09 quarter.

But over a one year period(as of Jul29 close), LLNW has actually outperformed AKAM and infact trades at a P/E multiple of 45.7 against's AKAM's P/E of 26.3.



Disclosure: No Positions