Akamai’s (NASDAQ:AKAM) shares have fallen almost 23% in less than a month after it announced its Q1 2012 April 25th. While the company reported strong revenue growth blowing away its own revenue guidance for the quarter, shares tumbled as the CEO announced that he was stepping aside. Further, the company guided for a near-term impact on operating margins as it incurs heavy costs related to the twin acquisitions of Cotendo and Blaze completed early this year. This month, Amazon (NASDAQ:AMZN) announced upgrades to its content delivery solution, CloudFront, to compete with Akamai and this has only added to the market nervousness.
However, we believe the concerns are overblown and that Akamai is positioned very strongly after the acquisitions to not only protect its margins in the long-term but also to ward off competition from low cost players such as Amazon.
Acquisition impact on margins only near-term
We have already discussed in our earnings report last month that the acquisition related costs being incurred are mostly one time in nature and will therefore have only a near-term impact on margins. Over the longer-term however, the acquisitions will help Akamai bolster its high-margin value-added services and grab more wallet share of its customers’ budgets (thereby increasing ARPUs). Further, it will also help alleviate the pricing pressures that increasing competition from a growing number of CDN rivals such as Amazon (NASDAQ:AMZN), Limelight Networks (NASDAQ:LLNW), Edgecast and Level 3 (NASDAQ:LVLT) is having on its core CDN margins. (see Akamai’s Fully Priced At $35 Despite Strong Revenue Growth)
Our DCF model for Akamai takes that into account the near-term negative impact on operating income and the long-term positive impact on gross margins to arrive at a price estimate of $35 for the stock, which is about 20% ahead of the market price. We also believe that Amazon’s CloudFront CDN solution isn’t as big a concern for Akamai as the markets currently seem to predict.
Amazon CloudFront upgrades not a concern for Akamai
For starters, this product is nothing new. Amazon has had this CDN service for a long time now, almost four years to be precise. Further, its offerings have always been priced much cheaper than Akamai’s as they are not as competent.
Moreover, Amazon and Akamai target different customers in the market place. Amazon’s cheaper pay-as-you-go model suits the needs of the smaller price sensitive customer while Akamai is usually after the deep pocket buyers such as Facebook and Netflix that use huge amounts of bandwidth and are hence willing to negotiate contracts on a volume basis. Akamai also has the scale to support larger organizations’ data traffic with over 100,000 servers installed in networks around the world that handle 15-30% of the global Internet traffic at any given time.
Amazon also announced support for dynamic content delivery in its upgraded CloudFront offering at the same price point as static content.  This is a significant value add for the price conscious customer since Akamai charges a premium for the same service. But the fact that Amazon goes after different customers and has neither the scale nor the speed to compete with Akamai for the high-end customer yet gives little reason to worry for Akamai. Further, the recent Cotendo acquisition gives Akamai access to the only other competent DSA (dynamic service acceleration) product in the market, making it the numero uno VAS (value-added services) player in the CDN market.
Value-added services have grown in importance over the past few years to account for close to 60% of Akamai’s total revenues in recent times. These services not only help Akamai protect its margins as CDN prices fall but also benefit from lesser competition in the market. Amazon is only beginning to position its CDN product to offer value-added services and it will be years before it can have the scale to start competing for Akamai’s customers. Akamai meanwhile will have leveraged the Cotendo acquisition to extend its VAS lead over rivals. (see Akamai’s Cotendo Deal a Win for Shareholders, Defends Moat)Notes:
- Amazon Web Services Launches Dynamic Content Support in Amazon CloudFront, MarketWatch, May 14th, 2012 [↩]