Akamai (NASDAQ:AKAM) said Thursday that it has reached an agreement to buy out Cotendo for a net cash payment of approximately $268 million. The move eliminates a key rival for Akamai in value-added services and also helps the company gain access to Cotendo’s Mobile Acceleration Technology. Founded in 2008 and backed by strategic partners such as Citrix, Juniper (NYSE:JNPR), Google (NASDAQ:GOOG) and AT&T (NYSE:T), Cotendo 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.
The news was well received by investors as Akamai’s shares rose almost 20% following the news, and it held on to most of its gains to close at $31.63. Our price estimate for Akamai is $31.74, in line with the market’s current bullish sentiment.
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Acquisition Will Help 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) and Level 3 (NASDAQ:LVLT) entered the market and started offering their services at cheaper rates. That shattered Akamai’s monopoly over the business and pressurized its margins. Its gross margins declined by a full percentage point last quarter, in spite of an increase in revenues.
The company has therefore been offering value-added services as a way to differentiate itself from rivals and protect the margins of its core content delivery business. However, we believe the emergence of Cotendo as a key player in this specialized high-margin offering, especially after its deal with AT&T, started to threaten the moat Akamai was building around its CDN business. Acquiring it will therefore minimize that risk for the time-being before other competitors catch on.
With Akamai now controlling a vast market share, it will be able to price its value-added offerings higher and therefore protect its overall margins. Cotendo priced its value-add services much cheaper than Akamai, Now, with lesser competition, Akamai may not want to renew Cotendo’s existing contracts at those cheaper rates. (see Akamai’s Cotendo Deal Would Add Margin Upside & Growth to Current $33 Value)
Cotendo recently added a mobile acceleration suite (MAS) to its value-added portfolio, a service we see huge potential in and think Akamai also has its eyes on. We expect this service to start being widely used as smartphones see mass-adoption and increasingly replace the PC as the primary computing and networking vehicle, making it essential for content providers to provide a solution that speeds up delivery of mobile websites and applications. (see With Cotendo Deal, Akamai Takes Out a Competitor & Gains Mobile Acceleration Technology)
Needless to add, Akamai will also gain access to Cotendo’s impressive clientele, who now have few options outside Akamai. So, all in all, we see this as a good move by Akamai.