Akamai Q4 Earnings: Media Delivery Business Shows Signs Of Slowdown, Value-Added Services Continue To Lead Growth

Akamai (NASDAQ:AKAM) released its 2015 fourth quarter & full year earnings report recently. ^[1] One takeaway from the earnings call was the fact that the company believes the media delivery business coming in from two of its largest clients will go down in 2016. ^[2] The likely reason for this drop is that these clients are diverting traffic to their own content delivery networks, a key feared event of investors that has pressured the stock. That said, the company outperformed expectations and the stock is up sharply as a result. We believe that even though the loss of business from some of its biggest clients will eat into Akamai’s future revenue growth, the company is not at immediate risk of losing a major portion of its revenue stream. Looking at Akamai’s 2015 performance, the strong demand for value-added services (VAS) such as security solutions and performance enhancement products led the growth in the company’s revenues. We believe that value-added services will continue to be Akamai’s growth driver in the near term. The company expects Q1 2016 revenue to be in the range of $554 to $570 million, which is in line with the consensus estimate of $567 million. ^[3]

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Media Delivery Segment Beginning To Face Headwinds

Akamai’s media delivery segment showed signs of slowing down in 2015. The segment’s revenues grew 7% for the full year 2015, a marked decrease from 2014 when revenues grew by 21%. ^[4] 2015 revenue growth was partly affected by currency fluctuations, as Akamai derives approximately 27% of its revenue from outside of the United States. However, the bigger headache for the company is that it expects media delivery business coming in from some of its biggest clients to go down in the near future. ^[2] This seems to be the after-effect of important customers such as Apple (NASDAQ:AAPL), Facebook (NASDAQ:FB) and Microsoft (NASDAQ:MSFT) diverting traffic to their own content delivery networks. ^[5] Clients such as Apple contribute significantly to Akamai’s revenues. ^[6] The company management stated on the earnings call that its largest two customers contribute 13% of overall revenues, and Akamai expects their contribution to fall to 6% in 2016. ^[7]

Pure-play content delivery network (CDN) market is becoming increasingly commoditized. Akamai is facing increased competition from rivals such as Level 3 (NYSE:LVLT), Limelight (NASDAQ:LLNW), Edgecast,  Amazon (NASDAQ: AMZN) and others.  This has heightened CDN pricing pressure in recent years. Additionally, there is a possibility that Akamai’s big clients could divert their traffic to their internal delivery networks on an accelerated schedule. Companies such as Netflix (NASDAQ:NFLX) and Google (NASDAQ:GOOG) were able to develop sustainable networks at a fast clip. Amazon went one step ahead and started offering CDN services to other companies, effectively becoming a competitor to Akamai. Nonetheless, companies such as Apple are still using Akamai’s services and we believe that fully shifting to an internal content delivery network will be a phased and prolonged project. There are also fears that this “do-it-yourself” trend might catch on and other customers might decide to follow in Apple’s footsteps, but the resources and time required for establishing their own CDN will not make economic sense for smaller Akamai clients. All this leads us to believe that even though loss of business from some of its biggest clients will eat into Akamai’s future revenue growth, the company is not at immediate risk of losing a major portion of its revenue stream.

Value-Added Services Segment Continues Strong Performance

Even though Akamai’s CDN business is facing headwinds, the company has managed to insulate itself to a certain degree by focusing on offering security, performance enhancement and other value-added solutions (VAS). VAS services make up almost half of Akamai’s revenues now and also have higher margins compared to pure-play CDN services.  Revenue from VAS services grew 20% on a constant currency basis during the full year 2015. ^[4] Among the various value-added solutions that Akamai sells, cloud security solutions products are experiencing the fastest growth and grew by 54% if we exclude the effect of currency fluctuations. ^[4] Akamai observed a more than 100% jump in DDoS attacks over its Prolexic network in the first half of 2015, as compared to the prior year period. ^{[8] [9]} The company has also warned of an uptick in DDoS reflection attacks in the coming quarters. ^[10] The increased threat to online security presents Akamai with an opportunity and the company has been enhancing its capabilities in order to better serve clients. 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 2022.

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1. Akamai Reports Fourth Quarter 2015 And Full-Year 2015 Financial Results, February 9, 2016, Akamai Press Release [↩]
2. Akamai Technologies (AKAM) Frank Thomson Leighton on Q3 2015 Results – Earnings Call Transcript, October 27, 2015, Seeking Alpha [↩] [↩]
3. Akamai up 16% after issuing better-than-feared guidance, February 9, 2016, Seeking Alpha [↩]
4. Akamai’s SEC Filings [↩] [↩] [↩]
5. Apple, Microsoft & Facebook Bring More Traffic To In-House CDNs, Impacting Akamai’s Media Business, October 28, 2015, StreamingMedia.com [↩]
6. Apple Building Out Their Own CDN To Deliver Content To Consumers, February 3, 2014, StreamingMedia.com [↩]
7. Akamai Technologies (AKAM) Frank Thomson Leighton on Q4 2015 Results – Earnings Call Transcript, February 9, 2016, , Seeking Alpha [↩]
8. Akamai’s State of the Internet Report Q2 2015 – Security, media.scmagazine.com [↩]
9. Q1 2015 State of the Internet Security .pdf, May 19, 2015, Akamai Community [↩]
10. Akamai Warns Of An Uptick In DDoS Reflection Attacks Using Abandoned Routing Protocol, July 1, 2015, Akamai Press release [↩]