Akamai’s Cotendo Deal Would Add Margin Upside & Growth to Current $33 Value

AKAM: Akamai logo

Akamai (NASDAQ:AKAM) may be planning to buy Cotendo for more than $300 million, according to a report published in the Calcalist Financial daily Sunday. [1] Cotendo is a smaller Israeli rival which competes with Akamai for value-added services founded in 2008 and launched in March of last year. The company has managed to raise over $36 million in funding from its investors like Sequoia Capital, Benchmark Capital and Tenaya Capital and also has the backing of strategic partners such as Citrix, Juniper (NYSE:JNPR), Google (NASDAQ:GOOG) and AT&T (NYSE:T). The private company has an impressive list of customers that use its dynamic site acceleration (DSA) and application acceleration services, including some big names such as AT&T, Facebook and Zynga.

Our price estimate for Akamai’s stock is $31, about 15% higher than the market price.

See our complete analysis for Akamai stock here

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Acquisition will help Akamai with its margins

Akamai had been the sole player in the content delivery market for many years before other Content Delivery Networks (CDN) such as Limelight Networks (NASDAQ:LLNW), InterNAP Network Services (NASDAQ:INAP) and Level 3 (NASDAQ:LVLT) entered the market and started offering their services at cheaper rates. Aggressive pricing saw prices decline in the CDN market, which has taken a toll on Akamai’s margins. Its gross margins declined by a full percentage point this quarter, in spite of an increase in revenues.

Increasing competition in its core business has forced Akamai to diversify by offering value-add services to augment its product portfolio and protect its margins. Akamai’s value-added offerings have grown from strength to strength to account for almost 50% of the company’s revenues in the absence of any other major player in the industry. (see Akamai Facing New Challenges in Value-Added Services) However, the emergence of new players in this rarefied market segment such as Cotendo threatened to pressure Akamai’s margins; a threat Akamai hopes to eliminate with this acquisition.

That Akamai recognized the increasing threat from Cotendo became apparent after it sued Cotendo for patent infringement last year. It had also sued competitors Digital Island and Speedera before going on acquire them as well. [1]

ARPU will also increase

Aside from decreasing pricing pressures, the acquisition would 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 allow it to price its combined services at higher price points and the company may see an increase in its average revenues per customer (ARPU) over time.

Cotendo priced its value-add services much cheaper than Akamai, but with a decrease in competition after the acquisition, Akamai may not want to renew Cotendo’s existing contracts at those cheaper rates.

It will also help it gain instant access to Cotendo’s very impressive list of customers. The company managed to sign about 400 customers in fewer than 20 months since its launch, which is a testimony to its strong customer-centric service offering that could benefit Akamai in the event of a take over. [2]

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

  1. Akamai in talks to buy Cotendo for $300 mln – report, Reuters, November 27th, 2011 [] []
  2. Cotendo Quadruples Customer Base and Goes Mobile Thanks to Equinix’s Dynamic Data Center Ecosystem, MarketWatch, Sepember 8th, 2011 []