Akamai Defends its Moat with Cotendo Acquisition

Akamai (NASDAQ:AKAM) announced last week that it has completed the acquisition of Cotendo, a smaller Israeli rival which was making some rapid strides in the value-added service arena of the content delivery world. ^[1] Founded in 2008 and backed by strategic partners such as Citrix, Juniper (NYSE:JNPR), Google (NASDAQ:GOOG) and AT&T (NYSE:T), Cotendo has made a name for itself with an impressive list of customers that use its dynamic site and application acceleration services, including some big names such as AT&T, Facebook and Zynga.

The move to buy out this rival not only defends the moat that Akamai has created around its CDN business but also gains it access to Cotendo’s impressive clientele and strong product offerings. Our price estimate for Akamai stock is $35, about 4% lower than the current market price.

See our complete analysis for Akamai stock here

Acquisition will help Akamai with its margins

Not so long ago, Akamai was about the only player in the content delivery market for many years. But slowly other Content Delivery Networks (CDN) such as Limelight Networks (NASDAQ:LLNW), Edgecast and Level 3 (NASDAQ:LVLT) entered the market and started offering their services at cheaper rates. Aggressive pricing saw prices decline in the CDN market, which took a toll on Akamai’s margins. Its gross margins have been declining over the last few years despite revenues growing at healthy double-digit rates.

In a bid stave off increasing competition in its core CDN business, Akamai decided to diversify by offering value-add services to augment its CDN product portfolio and protect its margins. Akamai’s value-added offerings have grown from strength to strength to account for almost 60% of the company’s revenues in the absence of any other major player in the industry. (see Akamai Rocks Q4 Results, Stems Margin Decline with Recent Deals) However, the emergence of new players in this rarefied market segment such as Cotendo threatened to pressure Akamai’s margins once again; a threat Akamai hopes to eliminate with this acquisition.

Revenues per User Will Increase

Aside from decreasing pricing pressures, the acquisition will 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 allow 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.

One of Cotendo’s value-added offerings that we believe has tremendous potential is its mobile acceleration suite (MAS) launched recently. As smartphones see mass adoption and increasingly replace the PC as the primary computing and networking vehicle, it is becoming highly essential for content providers to be able to speed up delivery of their mobile websites and applications.

As Dan Rayburn noted earlier, Cotendo’s value-add services are on an average about 30% cheaper than Akamai. ^[2] But with a decrease in competition after the acquisition, we believe that Akamai may not want to renew Cotendo’s existing contracts at those cheaper rates.

The acquisition will also help it gain instant access to Cotendo’s very impressive list of customers. The company managed to sign about 400 customers in fewer than 20 months since its launch, which is a testimony to its strong customer-centric service offering that could benefit Akamai in the event of a take over. ^[3]

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

1. Akamai Completes Acquisition of Cotendo, March 6th, 2012 [↩]
2. Cotendo In Talks To Be Acquired, Akamai The Likely Buyer, StreamingMediaBlog.com, November 28th, 2011 [↩]
3. Cotendo Quadruples Customer Base and Goes Mobile Thanks to Equinix’s Dynamic Data Center Ecosystem, MarketWatch, Sepember 8th, 2011 [↩]