Akamai Results Surprise On The Upside As Online Traffic Surges

| About: Akamai Technologies, (AKAM)
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Akamai (NASDAQ:AKAM) reported a very strong set of Q1 2013 numbers on April 24, beating its own guidance on both revenues and margins. Revenues for the quarter came in at $368 million, an 18% jump over the prior-year quarter when adjusted for the recently completed divestment of ADS (advertising decision solutions).

While revenues grew strongly across verticals, the guidance beat came mostly on strong traffic growth in the media division. Gross and EBITDA margins were also better than expected. Gross margins improved sequentially for the fourth consecutive quarter as the company drove efficiency in the delivery of Internet content and value-added services grew in strength, while EBITDA margins -- adjusted for one-time non-cash items -- came in at 45%, a couple of percentage points better than the high end of its guidance.

The company also continued to generate strong cash flows. Cash generation from operations rose to $103 million, about 28% of its revenues for the quarter. As a result of the surprise earnings beat and strong overall performance, Akamai's shares rose by almost 20% in trading Thursday. With the long-term growth trends of cloud computing, mobility and online video remain intact, we have revised our $41.50 price estimate for Akamai, almost in line with the current market price.

Demand for Online Video Continues to Grow

Revenue-wise, almost all of Akamai's verticals -- Media and Entertainment, Commerce, High-Tech and Public sector -- grew strongly. Most of Akamai's value (>70%), however, comes from the former two verticals, both of which are driven by strong online traffic growth and demand for online video. Internet traffic continues to surge, as social media, software downloads and online gaming grow at a frenetic pace. An increasing number of users are also accessing videos and other content from mobile devices such as smartphones and tablets. As a result, mobile data traffic is growing exponentially by almost 70% every year and is expected to grow thirteen-fold in the next five years, according to a new Cisco VNI report. Akamai, which delivers 15%-30% of all web traffic, stands to benefit hugely from this surge in online traffic.

It is worthy of note here that halfway through the March quarter, Akamai had indicated that it would be winding down some media contracts that were not adding too much value. The wind-downs, however, had little impact on results, which continued to remain solid aided by another strong quarter of strong online traffic growth. Akamai said that the traffic levels accelerated toward the end of the quarter, which should have a positive impact on Q2 results as well.

Growing Importance of Value-Added Services

The growth in online media streaming could have depressed margins due to the higher costs of delivery for large video files and software, but Akamai's recent investments in its network have led to greater efficiency in content delivery. This helped gross margins improve by more than four percentage points over the same period last year.

What has also contributed to the gross margin improvement in recent times has been the increased adoption of value-added services. Value-added services (VAS) -- such as dynamic site acceleration (DSA), application acceleration, front-end optimization (FEO), etc. -- have higher margins than basic content delivery, which has been commoditized by the entry of many players in the industry. It is therefore a welcome sign that these services have grown in strength to account for almost 60% of total revenues in 2012. As can be seen below, Akamai's margins recovered in 2012 from the lows of the previous year, and we expect the recovery to continue in the coming years as CDN prices stabilize and VAS supports margins.

In this regard, the acquisitions of Cotendo, Blaze, and other VAS providers will serve to bolster gross margins going forward. These acquisitions will not only reduce CDN pricing pressures, but also allow Akamai to strengthen its value added portfolio and help it gain share within the broader CDN market. Having a strong value-added service portfolio to augment its core CDN business will enable it to grab more wallet share of its customers as it upsells some of its other products. This may boost its average revenue per customer as well (see also: "Akamai's Cotendo Deal Would Add Margin Upside And Growth To Current $35 Value").

Disclosure: No positions.