Akamai Q2 Earnings Preview: Value-Added Services Will Drive Growth, But Currency Headwinds Likely Played The Minor Spoilsport

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Akamai (NASDAQ:AKAM) will release its third quarter earnings report on October 27th. [1] We expect the company will report strong growth in its value-added (VAS) services, such as security solutions and app accelerators. These services have high margins, which suggests that despite the increased competition within the content delivery network (CDN) business, Akamai can improve, or at least sustain, its margins in the near term. During the first half of the year, Akamai saw strong revenue growth across all reported segments without sacrificing much on margin front, suggesting a well-rounded performance and relatively low business risk. However, unfavorable currency movements will continue to have a detrimental effect on the company’s revenues in the near term. Taking a long term perspective, we believe that both teh CDN and VAS businesses will continue to grow and will be instrumental in increasing Akamai’s overall revenues from less than $2 billion in 2014 to more than $3.9 billion by 2022.

Our price estimate for Akamai stands at $72, which is roughly in line with the market price.

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See our complete analysis for Akamai here

Value-Added Services Will Boost Overall Growth

Akamai’s core CDN business is facing increased competition from other players such as Level 3, Edgecast, Limelight Networks and Amazon. This has put additional pressure on pure-play CDN businesses in recent times. However, Akamai has managed to mitigate the impact of this trend by focusing on improving performance and offering security and other value-added solutions through new service launches and acquisitions. VAS services make up almost 47% of Akamai’s revenues now and also have higher margins compared to pure-play CDN services.  Revenue from VAS services grew 22% on a constant currency basis during the first half of the year. [2] Among the various value-added solutions that Akamai sells, cloud security solutions products are experiencing the fastest growth and grew by 57%. [2] According to Forrester Research, at least 60 percent of enterprises will encounter a breach of sensitive data in 2015. [3] Akamai observed a record number of DDoS attacks over its Prolexic network in the second quarter of 2015, a 132% increase over the prior year period. [4] The company has also warned of an uptick in DDoS reflection attacks in the coming quarters. [5] Akamai senses an opportunity in the current situation and is enhancing its capabilities in order to better serve clients. (Related – Akamai Takes Strategic Steps With Focus On Security Solutions Business)

Akamai’s value proposition has evolved beyond being the fastest content delivery network. As competitors grow increasingly capable of fast content delivery at similar prices, Akamai has positioned itself as a full services provider—touting its ability to offer multiple value-added services such as security solutions, app accelerators, delivery of targeted advertising and cloud-based services for its customers. Akamai’s growing niche in the value-added services market should enable the company to wield more pricing power in the coming years. The additional revenue brought in by value-added products will push Akamai’s average revenue per subscriber higher. Accordingly, we believe that revenue per media business customer could cross $1 million by 2021.

Currency Fluctuations Will Continue To Take A Toll in the Near Term

The growth in Akamai’s core CDN services continues to be driven by the secular trends of increased online content and traffic, more business being conducted online, the increased demand for faster and more secure content delivery, and content providers striving to improve the experience of their users. During the first six months of 2015, the company’s overall revenues jumped 15% compared to the prior year period, with media delivery solutions growing by 12%. [2] However, currency fluctuations took a toll on revenue coming in from international markets. International revenue grew 7% during the first half of 2015 and 21% in constant currency terms. [2] We expect currency fluctuations to continue to play spoilsport in the short run, especially as Akamai derives 26% of its revenue from international operations. As far as the latest quarter is concerned, there were bound to be some headwinds due to currency movements, but business trends remain on the upswing. We estimate that more than 80% of the company’s value is driven by e-commerce and media traffic, which continues to surge as mobile devices proliferate and demand for social media, video streaming and online gaming grows at a frenetic pace. Consequently, we believe that Akamai’s total revenues will grow from under $2 billion in 2014 to $3.92 billion by the end of our forecast period.

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Notes:
  1. Akamai To Hold Third Quarter 2015 Investor Conference Call On Tuesday, October 27th At 4:30 pm ET, October 01, 2015, Akamai Press Release []
  2. Akamai’s SEC Filings [] [] [] []
  3. Planning For Failure, February 11, 2015, Forrester []
  4. Akamai’s State of the Internet Report Q2 2015 – Security, media.scmagazine.com []
  5. Akamai Warns Of An Uptick In DDoS Reflection Attacks Using Abandoned Routing Protocol, July 1, 2015, Akamai Press release []