Akamai Beats Guidance As Value-Added Services Drive $36 Value

Akamai (NASDAQ:AKAM) announced a strong set of Q2 2012 results, beating its guidance on both the revenue and margins front. Revenues for the quarter came in at $331 million, a 20% jump over the prior-year quarter and beating its guidance at the high-end. The revenue beat happened across all verticals and geographies, implying any impact to Akamai due to the prevailing  macro-economic concerns may be limited as businesses increasingly take to the Internet to reduce costs. Gross and EBITDA margins were also better than expected. Gross margins improved sequentially for the third consecutive quarter as the company drove efficiency in its delivery of Internet content and value-added services grew in strength, while EBITDA margins, adjusted for one-time non cash items, came in at 43%, a full percentage point better than the high end of its guidance.

Cash generation from operations increased to a record $150 million, almost 45% of its total revenues for the quarter. Year-to-date, the company has been able to convert almost 37% of its revenues to cash despite completing two big acquisitions of Cotendo and Blaze earlier this year. With the long-term growth trends of cloud computing, mobility and online video intact, we have revised our price estimate for Akamai’s stock to $36, in line with the current market price.

See our complete analysis for Akamai stock here

Demand for online video continues to grow

Revenue-wise, almost all of Akamai’s verticals, Media & Entertainment, Commerce, High-Tech and Public sector grew impressively at close to 20% rates each y-o-y. Most of Akamai’s value (>70%), however, comes from the former two verticals, both of which were driven by a strong traffic growth and demand for online video. An increasing number of users are also accessing videos and other content from mobile devices such as smartphones and tablets. It therefore bodes well that the company launched its own mobile site accelerator called the Aqua last quarter, and has also partnered with dominant mobile semiconductor player, Qualcomm, to speed up delivery of mobile content to devices sporting its Snapdragon chipsets.

Going forward, the London Olympic Games to start this week will be a big revenue generator for Akamai. The company believes that the event will attract at least a billion online viewers, both on wired and wireless networks. Akamai said that it is working with some of the biggest broadcasters and is prepared to deliver what it says will be an unprecedented amount of video content to viewers worldwide. While that may translate into a lot of revenues, gross margins may take a hit since large-size video delivery is a lot less profitable than other content. However, Akamai says that its networks have grown more efficient in delivering tons of data, as is evidenced by the third consecutive quarter of sequential gross margin improvement, so the margin hit may not be very severe.

Growing importance of value-added services

What has also contributed to the gross margin improvement in recent times has been an increased adoption of value-added services. Value-added services (VAS) such as dynamic site acceleration (DSA), application acceleration, front-end optimization (FEO), etc have higher margins than basic content delivery, which has been commoditized by the entry of many players in the industry. It is therefore a welcome sign that these services have grown in strength to account for almost 60% of the total revenues, as of Q2 2012. As can be seen below, Akamai’s margins have trended down over the past couple of years due to CDN pricing pressures, but we predict them to improve slowly in the coming years as CDN prices stabilize and VAS supports margins.

In this regard, the two acquisitions of Cotendo and Blaze will serve to bolster gross margins in the coming years. Both these acquisitions will not only reduce CDN pricing pressures but also allow Akamai to strengthen its value added portfolio and help it gain share within the broader CDN market as well. Having a strong value-added service portfolio to augment its core CDN business will enable it to grab more wallet share of its customers as it upsells some of its other products to customers. The company may therefore also see an increase in its average revenues per customer (ARPU) over time. (see Akamai’s Cotendo Deal Would Add Margin Upside & Growth to Current $35 Value)

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