Akamai's (AKAM) Q4 results are out, and the company beat expectations by 7%. Its share price jumped to $70.21, which is still 16% below its all-time high of $83.08. In this article, we are going to analyze Akamai's business, its opportunities, and if the current valuation is a good entry point or not.
The CDN business is a highly competitive industry where the competitors have to invest heavily in new talent, software, and hardware to keep their networks up to date. Akamai is one of the biggest CDN providers worldwide, and it has a well-established global infrastructure which gives it an edge over its competitors. Its biggest competitors in the CDN market and its respective website count market share are:
- Amazon (AMZN) CloudFront - 39.25%
- Cloudflare - 27.82%
- jsDelivr - 12.59%
- Fastly - 5.53%
Akamai follows on rank #5 with a market share of 3.73%. The comparison of website count market share doesn't represent how much traffic goes over the respective providers. Akamai is one of the largest content delivery networks because it has more than 200k servers deployed in more than 130 countries. None of the other providers comes close to Akamai's size, which is also reflected in the amount of web-traffic that goes through its network. Akamai measured that it delivered approximately 15-30% of the world's web traffic through its CDN platform.
Akamai's competitive edge
Akamai's primary competitive advantage is its sheer size and second its cloud security solutions which are on top of the industry. The company targets large customers like Facebook (FB), Amazon, Airbnb (AIRB), Microsoft (MSFT), and many more. While Amazon and Microsoft have their content delivery networks, the sheer size of Akamai's network makes it a necessity for those big companies to work with Akamai to deliver content to customers outside their networks. In the long run, this competitive edge can be a two-sided sword for Akamai because the largest customers continue to deploy its servers if it makes sense from a business perspective. Here is a quote from Akamai's latest quarterly report:
We have experienced increases in the amount of traffic delivered for customers that use our solutions for video, gaming, social media and software downloads, contributing to an increase in our revenue. However, our traffic growth rates are subject to fluctuation based on, among other things, when large events occur and the “do-it-yourself” efforts by some of our customers that are among the large Internet platform companies: Amazon, Apple (AAPL), Facebook, Google (NASDAQ:GOOGL) (NASDAQ:GOOG), Microsoft and Netflix (NFLX). We refer to these companies as our Internet Platform Customers. Some of these customers have elected to develop and rely on their internal infrastructure to deliver more of their media content, particularly less performance-sensitive content, rather than use our services. As a result, we have experienced lower revenue from these customers in recent years. We have not, however, been experiencing a significant shift to internal infrastructure usage across the remainder of our media services customer base."
Source: Akamai Quarterly Report September 2017
The biggest customers have the biggest incentive to build their own network of servers and deliver content to their customers, especially, Amazon, Google, and Microsoft which are also the three biggest cloud providers in the world. We can see this in the company's recent fourth-quarter results where revenue from internet platforms decreased by 14%, which includes customers like Netflix, Amazon, Apple, Google, Facebook and Microsoft. Their contribution to Akamai's revenue got smaller over the years, but the point is that other large customers, who are Akamai's target, might follow.
Akamai's business strategy looking forward
Akamai's income from its content delivery network is stagnating, and it switched its focus from content delivery to cloud security solutions which is its rapidly improving business segment. On the left side of the chart below, we can see that Media and Carrier division growth is now lower than that of its Web division which emphasizes the point that its content delivery segment is decelerating.
Source: Akamai Annual & Quarterly Reports
Its cloud security offerings are on top of the business, which is the reason for the sharp acceleration in this business segment. It makes up a quarter of its total revenue with YoY growth of 35% in 2018. It is now concentrating on this business segment as it is another growing competitive edge against its competitors.
Another point that I want to highlight is its international income, which makes up 38% of its total revenue. Akamai's highly distributed server structure makes it very attractive for international customers even though its price tag is relatively high compared to its competitors.
Looking forward, it is leveraging its server structure to create a zero-trust architecture that would protect businesses from outside attacks. It can do this by having one of the biggest networks of servers globally. If it would improve its price transparency and customer acquisition process on its website to make its services more accessible, I am sure that it will be able to boost its revenue.
Its network is its biggest asset and can be used to implement new technologies like a certain type of blockchain that would verify data transaction over its network in a very secure way.
After researching for content delivery networks, I found various rankings that list providers depending on the needs of customers. I found out these needs are mostly associated with small businesses or WordPress websites that want quick access to the service. If you solely go after these rankings, Akamai is often listed at the bottom of these rankings or not at all. Only when people research a little further, one sees that Akamai's large scale network exceeds those of its competitors by far. But as mentioned before it is not targeting small customers or individuals as of this writing, thus it remains the primary choice for enterprises and large businesses.
With a price tag of $70.21 per share, a P/E ratio of 39.89, and a PEG ratio of 1.11, investors are expecting the company to continue growing its business with a growth rate around 30% in the next years. Over the last 12 years, its margins have continuously decreased due to higher competition and more capital infusion in its business.
Source: Author's Calculation
The company's revenue growth has been decelerating in the last eight years and the high-growth days of the past more or less stay in the past.
Source: Author's Calculation
Is it reasonable to assume that Akamai's revenue growth will improve? I don't think so, and the reason is that different sources estimate that the CDN market growth will be around 30% CAGR and the growth in the cloud security market is expected to be about 13% CAGR. With Akamai's total web traffic share of 15-30%, and assuming that its market share wouldn't drastically increase (if it doesn't change its pricing structure or improve transparency to target a new customer base), I see its revenue continue to grow in the 6-9% range.
Investors are currently factoring in a growth rate of 30-36% into the share price, which reflects a slightly higher growth rate of the CDN market and cloud security market. We have to consider that Akamai's business is still weighted more towards the CDN market than the security market, which means that its security market has still more room to grow in the next 3-5 years.
Akamai's share price is currently reflecting an adequate growth for the next 3-5 years and considering the estimates for the CDN and cloud security market, I don't think that Akamai's share price will drastically increase over the next 3-5 years. Its valuation metrics show me that a lot of growth is already considered in the premium that investors pay. I would even go so far as to say that small changes in the demand for content delivery networks and cloud security solutions will profoundly impact Akamai's share price as it has in the past.
I like its business strategy and its competitive advantage in the market place, and at a lower price tag, I would consider Akamai as a good investment for long-term investors. At the moment I will continue to keep an eye on Akamai's share price and keep it on my watch list.
I always welcome constructive criticism and open discussions. Please feel free to comment or PM me about my calculations and/or sources that I use in my articles.
Author note: Seeking Alpha offers me the opportunity to articulate my thoughts and share them with other investors to get feedback and create constructive discussions about anything I say. I am not a financial advisor, and the information provided in my articles should not be used to make investment choices. Due diligence and/or consultation with your investment adviser should be undertaken before making any financial decisions, as these decisions are an individual's responsibility.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.