Akamai Doesn’t Have Much To Gain From iOS Upgrades

With Apple (NASDAQ:AAPL) customers rushing to update their respective iDevices to iOS7, Akamai (NASDAQ:AKAM) is seeing strong traffic growth on its CDN network. The dominant CDN provider has had a long-standing strategic relationship with Apple starting way back in 1999 when Apple had bought 5% of Akamai’s stock. As a result, although Apple has looked to diversify by adding Level 3 as its second CDN partner last year, Akamai’s tight integration with Apple’s web store means that it still accounts for a majority of the iOS web traffic. ^[1] To get an idea about how huge this traffic is, Akamai’s web monitor showed global traffic levels shoot up to about 126% above normal soon after the iOS 7 update was made available for download. Being Apple’s major CDN partner, Akamai stands to gain from this huge surge in traffic, and investors have therefore driven its stock up by over 11% in the past month.

However, considering the size of Akamai’s software and gaming delivery business, the iOS7 launch doesn’t seem to be a very big driver of value. Not only does Akamai generate only about 16% of its revenues from its software and gaming customers, but it also incurs higher costs on delivering the large files. By our estimates, Akamai’s gross margins in software delivery are about 75% – close to the company average but lower than its online shopping business which has margins of almost 85%. As a result, Akamai’s software delivery business accounts for only about 12% of our $45 price estimate for Akamai.

See our complete analysis for Akamai here

How many users will upgrade to iOS 7?

In order to analyze how much Akamai could generate from the iOS 7 launch, we estimate the number of iOS devices currently in use and use streaming and online video expert Dan Rayburn’s estimate for average CDN prices in the industry. Cumulatively, Apple has sold about 750 million iOS devices so far. However, not all of these can be reasonably expected to still be in the market or upgradable to iOS7. Apple itself allows only iPhones since the iPhone 4, iPads since the iPad 2 and the 5th-generation iPod Touch to be upgraded to iOS7.

Since the iPhone 4 was launched in 2010, we make iPhone estimates for the past four years only. Assuming that all the iPhones sold in the past two years are still in the market, along with about 35% and 15% of those sold in 2011 and 2010 respectively, there could be around 280 million iPhones currently in use and eligible for an iOS7 upgrade. Our estimates are driven by the fact that most of the iPhones sold are through carriers, whose subsidies ensure that customers upgrade every two years. Some of the older phones which are refurbished and sold second-hand, especially in the emerging markets, are also included in our estimate.

For the iPad, we make estimates from 2011 onwards since the original iPad is excluded from the iOS7 update. Here again, we assume that all the iPads sold in the past two years are still in use, along with about 60% of those sold in 2011. This gives us about 150 million iPads that will be updated to iOS7 in the coming months.

The iPod Touch numbers are relatively easier to calculate since the 5th generation iPod Touch was launched only late last year and Apple routinely says that the Touch accounts for more than half the iPods sold every quarter. Through the quarter ended September, we estimate that about 27 million iPods were sold of which about 50%, or about 14 million, were the 5th-generation Touch. The 32 GB 4th generation iPod Touch, which was discontinued in May, is likely to have accounted for far less and hence ignored in our analysis.

Adding the numbers, we arrive at a grand total of about 450 million iOS devices in use that are eligible for the iOS7 upgrade.

Minimal upside to Akamai

The iOS 7 update file is about 750 MB in size for smaller devices such as the iPhone and the iPod Touch and upwards of 1GB for the iPad. Assuming that all the 450 million Apple users upgrade their devices by the end of the year and that all traffic is routed through Akamai’s CDN network, Akamai is likely to have delivered about 370 million GB in iOS7 downloads by 2013-end. According to Dan Rayburn, CDN prices ranged from about $0.01-0.03 per GB delivered in 2012. These prices are likely to have declined in the past year but even the most aggressive estimate generates only about $11 million in iOS7 download revenues for Akamai. ^{[2] [3]}

For a company with a market capitalization of over $8 billion and annual revenues likely to exceed $1.5 billion this year, the annual iOS upgrade ritual doesn’t seem like a very big value contributor. If we follow the same procedure as highlighted above and Trefis estimates for iDevice sales, we find that the number of iOS devices in use that are eligible for upgrade each year will grow to about 950 million by 2020. Assuming that CDN prices decline by a CAGR of 7% over the same period, Akamai will be generating revenues of about $14-15 million from iOS updates by the end of our forecast period. This translates into a long-term EBITDA upside of only $6 million and valuation upside of less than $50 million, or about $0.25 per share.

Admittedly, some of the iOS downloads are costlier for Apple (and hence more profitable for Akamai) due to bandwidth constraints in emerging markets but there are not likely to be too many of them. Apple generated only about 20% of its revenues from emerging markets in FY 2012, and even less historically. Moreover, while CDN prices have declined by over 20% in the last four years, we have assumed a future CAGR decline of only 7% in our analysis. Our aggressive estimate for CDN pricing should therefore take care of any emerging market bumps.

Understand How a Company’s Products Impact its Stock Price at Trefis

1. Level 3 Wins CDN Contract With Apple For Software Downloads, Dan Rayburn, StreamingMediaBlog [↩]
2. CDN pricing, Dan Rayburn, September 2012 [↩]
3. By My Estimates, Apple’s iOS 7 Download Business Is Worth About $10-$12M To Akamai [↩]