Akamai (NASDAQ:AKAM) plans to announce its Q3 2012 earnings on October 24. Last quarter was particularly good for Akamai as it beat its guidance both on revenues and margins. The company expects to continue its performance in Q3 as well, recently reaffirming its revenue guidance which at the mid-point is about 20% higher than the same period last year. We will be looking at the geographic revenue split to see if the company is seeing any near-term pressures from the ongoing macro-economic concerns due to the Eurozone debt crisis. Akamai has said that its network management initiatives are helping bring down costs, and we will closely watch its gross and EBITDA margins to see that effect.
The company has so far managed to generate strong cash flow in 2012. Year-to-date, it converted almost 37% of its revenues to cash despite completing two big acquisitions of Cotendo and Blaze earlier this year. With the long-term growth trends of cloud computing, mobility and online video intact, we maintain our $36 price estimate for Akamai’s stock, almost in-line with the market price.
Demand for online content on the rise
In terms of revenue, almost all of Akamai’s verticals like media & entertainment, commerce, high-tech and public sector are growing impressively. Most of Akamai’s value (>70%), however, comes from the first two verticals, both of which are driven by strong traffic growth and demand for online video. An increasing number of users are also accessing videos and other content from mobile devices such as smartphones and tablets. It hence bodes well that the company has launched its own mobile site accelerator called Aqua this year, and has partnered with dominant mobile chipset manufacturer Qualcomm to speed up delivery of mobile content to devices sporting its Snapdragon chipsets.
This quarter we expect Akamai’s revenues to have received a boost from the the London Olympic Games, which could have attracted a billion online viewers globally. Akamai worked with some of the biggest broadcasters covering the Olympics, and could well have delivered an unprecedented amount of online video content to viewers worldwide. While that may have translated into substantial revenue, gross margins may have taken a hit since large-size video delivery is a lot less profitable than other content. However, Akamai has said that its networks have grown more efficient in delivering tons of data as was evidenced by the third consecutive quarter of sequential gross margin improvement last quarter, so the margin hit may not be very severe.
Growing importance of value-added services
What has also contributed to the gross margin improvement in recent years has been the increased adoption of value-added services. Value-added services (VAS) such as dynamic site acceleration (DSA), application acceleration, and front-end optimization (FEO) have higher margins than basic content delivery, which has been commoditized by the entry of multiple players in the industry. It is therefore a welcome sign that these services have grown in strength to account for almost 60% of Akamai’s total revenues, as of Q2 2012. As can be seen below, Akamai’s margins have trended down over the past couple of years due to CDN pricing pressures, but we project them to improve slowly as CDN prices stabilize and VAS supports margins.
In this regard, the two acquisitions of Cotendo and Blaze will serve to bolster gross margins going forward. 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 grab more wallet share of its customers as it upsells some of its other products. The company may hence also see an increase in its average revenue per customer (ARPU) over time. (see Akamai’s Cotendo Deal Would Add Margin Upside & Growth to Current $35 Value)