Akamai (NASDAQ:AKAM) announced record results for Q1 2012 after the markets closed on Wednesday blowing away its own revenue guidance for the quarter but shares fell as heavy acquisition related costs took a toll on earnings.
Going forward, we expect the acquisitions 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.
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Minimal seasonality impact
Revenue for the quarter came in above their guidance range at more than $319 million, which was a growth of 16% year-over-year. Cotendo’s acquisition, which was completed only at the end of the quarter in March, contributed less than $2 million to that figure. The solid revenue growth was however not matched by earnings, which fell 15% over Q1 2011 on higher taxes and other one time costs related to the acquisition of Cotendo and Blaze completed in the quarter.
After a phenomenally strong holiday quarter when Akamai was helped by a seasonal spurt in online shopping activity, we expected a slowdown in sales this quarter. While there was a slowdown, it was not very pronounced. Akamai was most helped by its Commerce and Media & Entertainment verticals, which grew 14% and 21% over the year-ago quarter respectively. Sequential declines in the respective divisions were a modest 7% and 2% only. Combined, the two divisions account for almost 70% of Akamai’s total value and are therefore the most important for our price estimate for the company.
Growing importance of value-added services
Continued growth in Akamai’s value-added offerings helped the company’s gross margins improve for the second consecutive quarter. Akamai’s gross margins improved to 79.6% from the 79.3% posted last quarter, mostly due to strong top-line growth and strength in its value-added portfolio. This a welcome sign for the company that has had to contend with pricing pressures from rivals in the recent past. As shown below, Akamai’s margins have trended down over the past couple of years in the face of increasing competition.
In this regard, the two acquisitions of Cotendo and Blaze will serve to improve margins further 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 as well. 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 $35 Value)
However, in the near-term, Akamai’s operating expenses associated with the twin acquisitions will continue to mount, taking a toll on net income. Akamai has even guided for a higher tax impact for the full year compared to its earlier guidance as a result of the acquisitions. Immediately following the results, Akamai’s stock fell almost 7% in after market trading. Accounting for the near-term impact on operating income and the long-term impact on gross margins, we maintain our $35 price estimate for Akamai stock, about 4% below the current market price.