Akamai (NASDAQ:AKAM) plans to announce its Q4 2011 earnings on Wednesday. During the last quarter’s earnings call, Akamai reported better than expected year-over-year revenue growth that sent the stock up 15% the very next day. This had come as a welcome respite for a stock that has shed about half of its value over the past four quarters. The subsequent Cotendo acquisition announcement acted as another big trigger sending the stock further up to a six-month high now. For the stock to hold these levels or climb higher, Akamai will have to meet its earlier guidance of a 8-12% sequential growth in revenues and guide for a better 2012. While the Cotendo deal will help Akamai protect its margins for its value-added offerings, the pricing pressures that Akamai has been facing from competitors such as Limelight Networks (NASDAQ:LLNW), Edgecast and Level 3 (NASDAQ:LVLT) for its core content delivery network (CDN) service may continue to be a deterrent.
Strong Q4 to help Akamai meet guidance
For Akamai, Q4 has seasonally been its strongest quarter mostly due to a spurt in online retail and advertising spending during the holiday season. We expect this to help Akamai meet its revenue guidance for the quarter. This may however come at the expense of its core CDN business margins, which have of late been under pressure from aggressive pricing tactics employed by competitors such as Edgecast, Level 3 and Limelight Networks. Its gross margins declined by almost a full percentage point last quarter in spite of the increase in revenues.
However, its higher-margin value-added service (VAS) offerings may serve to offset some of those losses. Last quarter, Akamai had seen a strong customer adoption of its value-added service portfolio, driven mostly byDynamic Site Acceleration, or DSA, solutions which saw almost 100 signings across all verticals. Since these VAS offerings have still not been subjected to the same pricing pressures as its CDN business, a continued growth in customers adopting these services will help Akamai protect its margins. The Cotendo acquisition was also made with this in mind (see Akamai’s Cotendo Deal Would Add Margin Upside & Growth to Current $33 Value)
Cotendo acquisition to bring in more CDN customers
Aside from decreasing pricing pressures, the acquisition will 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 price its combined services at higher price points and the company may see an increase in its average revenues per customer (ARPU) over time. Cotendo priced its value-add services much cheaper than Akamai, but with a decrease in competition after the acquisition, Akamai may not want to renew Cotendo’s existing contracts at those cheaper rates.
However, since the deal was announced only towards the fag end of the quarter, we don’t expect it to have helped Akamai’s margins this quarter. Akamai’s margins have fallen by almost 3% over the past year but we expect the slide to abate over the coming quarters, as new value-added customers sign up with Akamai and Cotendo’s older contracts are renewed at higher price points.