Akamai Earnings: Looking At Traffic Growth And Margins

Akamai (NASDAQ:AKAM) is expected to announce its Q2 2013 results on July 24th. The company is seeing unexpectedly high growth in its traditional CDN business as consumers increasingly access the web for streaming videos, accessing social media, shopping and playing online games. Last quarter, Akamai beat its own guidance on both revenues and margins, mostly on strong traffic growth in the media division. The outperformance was driven by the media delivery business, which grew 4% sequentially despite the company winding down some of its less profitable media contracts during the quarter. On the other hand, the higher-margin value-added services declined 3% sequentially over the seasonally strong holiday quarter.

See our complete analysis for Akamai stock here

The surprisingly high growth in the commoditized CDN business caused Akamai’s stock to pop almost 20% on the day the earnings was announced. Since then the stock is up another 5% supported by the rally in the broader markets. The company has guided for traffic growth, which had accelerated towards the end of last quarter, to continue into Q2 as well. While this does point to another strong quarter for Akamai, what is really important for investors this earnings call is the guidance for the next quarter as well as the full year. One of the biggest risks surrounding Akamai’s CDN business right now is the uncertainty associated with predicting near-term traffic growth – something that could dent expectations and was alluded to by the company’s CEO at a JPMorgan conference in May.

“Traffic prediction is an inexact science. Traffic levels can change based on the dates of software releases, how many apps you download into your cellular devices, how many games get distributed. I think we do a pretty good job of predicting the traffic, but it’s not perfect.”

Our $41.50 price estimate for Akamai is about 7% below the current market price.

High traffic growth may be unsustainable

The evidence of this near-term volatility could be seen in the Q4 2012 report as well when the company had disappointed the markets by posting weaker-than-expected growth in revenues in what was supposed to be a seasonally strong quarter. The issue here is that due to high competition in the commoditized CDN business from the likes of Level 3 Communications, Limelight Networks, Edgecast and, more recently, Amazon, pricing levels in pure content delivery have been declining by 15-20% every year. ^[1] This makes it necessary for Akamai to sustain the high traffic growth in the coming quarters in order to offset the impact of falling prices. While the fundamentals of the industry that Akamai operates in remain solid, with mobile data traffic growing exponentially every year, Akamai may find it tough to maintain the historically high growth rates with the base rapidly increasing every year.

The recently released Cisco VNI report paints a very rosy picture of mobile data traffic in the coming years, predicting 66% CAGR over the next five years. However, the 2012 mobile data traffic figure of 0.9 exabytes per month (EBM) is about 30% lower than the previously estimated figure of 1.3 EBM for the year. ^[2] Where the report had previously estimated mobile data traffic to reach about 11 EBM by 2016, it now expects the same to happen by 2017. The tempering of expectations may not be a sign of bearishness considering that Cisco still expects a growth rate of over 65% in the next few years, but it does show the risks attached to expecting very high data traffic growth rates in the coming years.

Akamai’s media content delivery business has managed to grow revenues by about 11% CAGR in the last four years. We estimate the growth to gradually taper down from an estimated 18% in 2013 to about 4% by the end of the forecast period for an average CAGR of about 5%. In order to justify the current market valuation, we estimate that the recent content delivery outperformance needs to sustain itself at the historical CAGR of more than 10% over the term of our forecast period.

Value-added services growth slows

Aside from the data traffic volatility, another concern with Akamai is that demand for its newer value-added services (VAS) seems to be slowing down a bit. While Akamai started offering these cloud infrastructure solutions as a means to diversify its revenue streams toward higher margin products, they have grown in importance to account for more than half the company’s current revenues. It is therefore disappointing that the company had a weaker-than-expected holiday season last year in terms of online e-commerce traffic, and then followed it up with a 4% sequential decline in performance and security solutions last quarter.

While the near-term out-performance in the traditional CDN business has more than offset the weakness in VAS, the fact that Akamai’s higher-margin business is facing headwinds could could have a long-term impact on margins. If the CDN traffic growth doesn’t sustain, the impact of a VAS slowdown could be even higher.

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

1. CDN Pricing Stable: Survey Data Shows Pricing Down 15% This year, Dan Rayburn, September 12th, 2012 [↩]
2. Cisco Mobile Data Traffic Report 2011, Cisco Mobile Data Traffic Report 2012 [↩]