Akamai (NASDAQ:AKAM) plans to announce its Q4 2011 earnings on Wednesday. Last quarter was particularly good for Akamai as a growing holiday traffic helped the company blow away its own revenue guidance for the quarter and sent its shares flying 13% on the day of the results. However, the stock has grown only marginally since then, in line with our expectations of a seasonal slowdown in the company’s businesses.
During the earnings call, we will carefully evaluate how slow Q1 was as well as the company’s guidance for the impact of Cotendo’s acquisition on its revenues and gross margins in the coming quarters. We expect the Cotendo deal to help Akamai protect its margins for its value-added offerings and offset the pricing pressures from competitors such as Google (NASDAQ:GOOG), Limelight Networks (NASDAQ:LLNW), Edgecast and Level 3 (NASDAQ:LVLT) in its core CDN service, going forward.
We have a $35 price estimate for Akamai stock, about 6% lower than the current market price. Our price estimate takes into account the risk that the seasonal slowdown could be more pronounced than in the past, considering how exceptionally strong the last quarter was. We will update our price estimate, depending on how the Q1 results turn out to be.
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Growing importance of value-added services
Growing competition from rivals such as Limelight Networks (NASDAQ:LLNW), Edgecast and Level 3 (NASDAQ:LVLT) have had an adverse impact on the company’s core CDN margins. As shown below, Akamai’s margins have trended down over the past couple of years under the weight of these pricing pressures.
However, the decline could have been even more pronounced if Akamai hadn’t started offering value-added services (VAS) to counter the growing competition. While competition continued to eat away at its core business margins, it was able to offset those losses with higher margins on value-added offerings. These services also served to bolster its product portfolio and over the years have grown in importance, not just as a pricing hedge but also as a growing source of revenue. Value-added services accounted for about 58% of total revenues, as of Q4 2011.
Sustained growth in Akamai’s value-added offerings helped the company stem the sequential decline in gross margins last quarter. The company’s gross margin for the quarter improved more than 200 basis points over the previous quarter and was the highest for the year. It will be interesting to see if the company manages to sustain that increase this quarter or not.
In either case, the two acquisitions completed by the company during the March quarter, Cotendo and Blaze, should bolster the company’s margins in the coming years. Both these acquisitions will not only reduce CDN pricing pressures but 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 enable it to price its combined services at higher price points, and the company may also see an increase in its average revenues per customer (ARPU) over time. (see Akamai’s Cotendo Deal Would Add Margin Upside & Growth to Current $33 Value)