Growing Demand For Video, E-Commerce Will Drive Akamai’s Earnings

Akamai (NASDAQ:AKAM) is to announce its Q4 2012 earnings on February 6. Last quarter was particularly good for Akamai as it beat its guidance both on revenues and margins. Revenues for the quarter came in at $345 million, a solid 23% jump over the prior year quarter and beating its guidance at the high end. The revenue beat happened across all verticals and geographies, implying that any impact to Akamai due to the prevailing  macro-economic concerns may be limited, as businesses increasingly take to the Internet to lower costs.

Gross and EBITDA margins were also better than expected. Gross margins improved sequentially for the fourth 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 45%, a couple of percentage points better than guidance.

Year-to-date, the company has been able to convert almost 40% of its revenues to cash despite completing three acquisitions of Cotendo, Blaze and Fastsoft this year. We will watch the the geographic revenue split to see if the company is seeing any near term pressures from the ongoing macro-economic concerns due to the Eurozone debt crisis. Akamai has said that its network management initiatives are helping bring down costs, and we will closely watch its gross and EBITDA margins to see that effect.

See our complete analysis for Akamai stock here

Demand For Online Video Continues To Grow

In terms of revenue, almost all of Akamai’s verticals, media & entertainment, ecommerce, 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. A growing 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 Ion, and has also partnered with dominant mobile semiconductor player, Qualcomm, to speed up delivery of mobile content to devices sporting its Snapdragon chipsets.

Akamai also benefited from the London Olympic Games, which was a big revenue generator for the company. This was not only in terms of the huge amount of video content that it delivered to viewers worldwide but also the use of its web security suite, Kona Security Solutions, to protect websites from attacks. The company’s Fastsoft acquisition should help further improve efficiency and increase margins. Akamai is expected to report improving gross margins in the fourth quarter as well.

Growing Importance Of Value-added Services

What has also contributed to the gross margin improvement in recent years, has been the increased adoption of value-added services. Value-added services (VAS) such as dynamic site acceleration (DSA), application acceleration and front-end optimization (FEO), have higher margins than basic content delivery, which has been commoditized by the entry of multiple players in the industry. It is therefore a welcome sign that these services have grown in strength to account for almost 60% of Akamai’s 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 project them to improve slowly as CDN prices stabilize and VAS supports margins.

In this regard, the two acquisitions of Cotendo and Blaze will serve to bolster gross margins going forward. 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. Having a strong value-added service portfolio to augment its core CDN business will enable it to grab more wallet share from its customers as it upsells some of its other products. Hence, the company may also see an increase in its average revenue per customer (ARPU) over time. (see Akamai’s Cotendo Deal Would Add Margin Upside & Growth to Current $35 Value)

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