Akamai: Softening Business And Reduced Guidance

May 25, 2022 2:31 PM ETAkamai Technologies, Inc. (AKAM)AMZN, GOOG, GOOGL, MSFT2 Likes
Michael Fitzsimmons profile picture
Michael Fitzsimmons
18.38K Followers

Summary

  • Due to the company's softening business, reduced guidance, and the current macro investment environment, I am lowering my rating on AKAM from BUY to HOLD.
  • While Q1's results were relatively "ok", the outlook for the rest of the year is cloudy and after being goosed by the pandemic, AKAM's CDN business will likely be flat.
  • As I previously reported, AKAM's cybersecurity solutions will continue to be a bright spot and grew ~25% in Q1. Cybersecurity remains the primary investment theme in my opinion.
  • However, in the short-term, FY22 guidance was reduced on headwinds from foreign exchange, the corporate tax rate, and Russia/Ukraine.

Akamai Technologies headquarters in Silicon Valley

Sundry Photography/iStock Editorial via Getty Images

During the pandemic, Akamai (NASDAQ:AKAM) was able to successfully leverage its legacy global content delivery network ("CDN") footprint to deliver growth for shareholders because businesses and consumers accelerated the digital transformation causing internet traffic to balloon. Indeed, AKAM's revenue for FY2021 was up 8% yoy while GAAP EPS of $3.93/share was up 17% yoy. However, AKAM's Q1 release was relatively soft and guidance was lowered due to a number of recent developments. As a result, I am changing my rating from BUY to HOLD.

Investment Thesis

Akamai has leveraged its legacy CDN into arguably the world's largest cloud edge-computing platform:

Akamai's Edge Platform

Akamai

While the potential for growth would appear to be high, there are - of course - large competitors such as Google (GOOG), Microsoft (MSFT) and Amazon (AMZN) and the associated pricing pressure. That is one reason AKAM has been focusing on growing its cybersecurity business and recently closed its $900 million acquisition of Linode: to bolster its distributed cloud-computing platform solutions in areas like edge-computing and security. Note Linode had 179,000 users in April (see the 2022 Analyst Day slides) and is very popular among developers.

And - in my opinion - cybersecurity remains the primary investment thesis in Akamai given the company's demonstrated ability to grow that business at a 20-25% CAGR. As shown below, AKAM offers a full-line of security solutions for infrastructure & applications as well as a suite of "Zero Trust" offerings for enterprises both large and small. Note the Zero Trust segment grew FY21 revenue 140% yoy:

Akamai's Security Business

Akamai

Akamai is also an acknowledged global leader in protecting against DDoS ("distributed denial-of-service") attacks.

As for the overall cybersecurity market, Statista research shows:

  • Revenue in the Cybersecurity market is projected to reach $146.30 billion in 2022.
  • Cybersecurity Revenue is expected to show a CAGR of ~9.7% for the 2022-2026 time frame, resulting in a ~$211 billion market by 2026.

So let's take a closer look at Akamai.

Earnings

AKAM's Q1 EPS report was released early in May and was roughly inline (or a slight miss) with guidance and expectations:

  • Q1 revenue of $904 million was up 7% yoy (+9% when adjusted for foreign exchange).
  • U.S. revenue was $481 million, up 4% yoy; International revenue was $423 million, up 11% yoy.
  • Security and Compute revenue grew 25% yoy.
  • Security revenue of $382 million was up 23% yoy.
  • Compute revenue of $78 million was up 32% yoy.
  • GAAP EPS of $0.73/share was down 22% yoy while non-GAAP EPS of $1.39/share was up 1% yoy.

AKAM reported that it had notched several notable Guardicore wins in the quarter, and that the company continues to be "enthusiastic about our potential to transform the cloud landscape with our Linode acquisition."

Note that net cash-from-operations in Q1 of $222.5 million (25% of revenue) was $27.3 million lower than CFO in Q1 of last year.

Cash, cash equivalents and marketable securities totaled $1.3 billion as of March 31, 2022. That was down from $2.2 billion at year-end 2021 (most of the decline was due to acquisition expense).

During the quarter, Akamai spent $103 million to repurchase 0.9 million shares of its common stock at an average price of $111.25 per share. At present time, the stock is currently trading at $99.47. Akamai had 161 million shares of common stock outstanding as of March 31, 2022... which, despite the share buyback program, is exactly the same number of shares the company reported having as of year-end of 2021.

Outlook

Along with the Q1 results, AKAM also issued new guidance for Q2 and full-year 2022:

Akamai FY22 guidance

Akamai

Guidance was lowered due to a number of developments: negative FX impact, a 1.5% higher than expected tax-rate, and the negative impact of events in Russia and Ukraine.

Note the mid-point of both Q2 revenue and non-GAAP net income guidance indicate a sequential drop as compared to Q1.

The mid-point of non-GAAP EPS ($5.38/share) indicates a forward P/E 18.5x, which is fair considering $5.38/share would be lower as compared to non-GAAP EPS of $5.74 last year. Clearly, AKAM's business is decelerating from a bottom line perspective.

AKAM's core CDN business was down 6% yoy in Q1 and it is likely to keep struggling, in my opinion, as large customers, such as Netflix, continue to pull their CDN in-house.

Risks

AKAM is certainly exposed to the macro environment (the global pandemic, Putin's invasion of Ukraine and the resulting sanctions placed on Russia by the US and its Democratic & NATO allies, high inflation, higher interest rate outlook, etc.) and the resulting impact that a potential slower global economy could have on online traffic.

AKAM's global CDN network means it is exposed to foreign exchange impacts due to a stronger US$. Meantime, there are integration risks with AKAM's two recent acquisitions (Linode and Guardicore), but upside risks as well if the security products gain traction in the market. I wouldn't be surprised to see AKAM's CDN business decline annually for the next few years. That said, local-caching and online near real-time gaming - which are sensitive to even small network delays - could prove to be positive catalysts for AKAM.

As for Russia specifically, co-founder and CEO Tom Leighton made these comments on the Q1 conference call:

... about 1% of our revenue comes from Russian companies or is derived from delivering traffic into Russia. We have since terminated our business with several majority state-owned Russian companies and our traffic delivered into Russia and Ukraine on behalf of other global customers has declined dramatically since the war began. As a result, it's reasonable to assume that we will no longer generate most of the revenue that had been associated with Russian and Ukraine.

However, the impact of Russia/Ukraine was already incorporated into the guidance given earlier in the article.

Summary & Conclusion

AKAM has a very solid business and its cybersecurity solutions are popular. Indeed, I fully expect AKAM's cybersecurity business to grow 20-25% for the next few years. However, the legacy CDN business is struggling and I don't think that will change anytime soon. In addition, the share buyback program is arguably not a good use of shareholder capital as the outstanding share count remained the same despite $103 million in share buybacks during Q1. And, note that the shares were bought at an average price almost $12 above where the stock is currently trading. The company would be better off, in my opinion, allocating much of the money it is spending on share buybacks to reducing interest expense on its $2.2 billion in long-term debt and by rewarding investors with some dividend income.

Given the current market environment, and the company's estimated forward P/E of 18.5x based on the midpoint of its FY22 guidance, I don't see any reason to buy shares at the present time. As a result, I reduce my rating from BUY to HOLD. If the shares dropped into the low $80's, I would become interested.

I'll end with a 10-year price chart of Akamai stock:

AKAM price chart
Data by YCharts

This article was written by

Michael Fitzsimmons profile picture
18.38K Followers
Technology stocks, ETFs, portfolio strategy, renewable energy, and O&G companies. Primary goal is growing net-worth. I typically allocate a portion of my own portfolio and devote some of my SA articles to small and medium sized companies offering compelling risk/reward propositions. I am an Electronics Engineer, not a qualified investment advisor. While the information and data presented in my articles are obtained from company documents and/or sources believed to be reliable, they have not been independently verified. Therefore, I cannot guarantee its accuracy. I advise investors conduct their own research and due-diligence and to consult a qualified investment advisor. I explicitly disclaim any liability that may arise from investment decisions you make based on my articles. Thanks for reading and I wish you much investment success!
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Disclosure: I/we have a beneficial long position in the shares of AMZN, GOOG either through stock ownership, options, or other derivatives. 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.

Additional disclosure: I am an electronics engineer, not a CFA. The information and data presented in this article were obtained from company documents and/or sources believed to be reliable, but have not been independently verified. Therefore, the author cannot guarantee their accuracy. Please do your own research and contact a qualified investment advisor. I am not responsible for the investment decisions you make.

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