Akamai (NASDAQ:AKAM) announced a strong set of Q2 results Wednesday, as strong traffic growth and faster than anticipated demand for its IP accelerator solutions helped the company report revenues and operating margins at the high-end of its guidance. Revenues for the quarter came in at $378 million, a 19% jump over the prior-year quarter when adjusted for foreign currency headwinds and the recently completed divestment of ADS (Advertising Decision Solutions). Akamai continued to wind down less valuable media contracts during the quarter, but the impact was more than offset by a strong growth in web traffic driven by social media, gaming and video consumption.
While revenues grew strongly across verticals, what exceeded expectations was the demand for Akamai’s performance and security value-added services which grew by 7% sequentially and 19% y-o-y. Cash gross margins continued to benefit from Akamai’s efforts at driving efficiency in the delivery of Internet content, increasing by 3 percentage points over the same period last year. This helped EBITDA margins beat guidance growing by 100 basis points over Q2 last year. Going forward, however, the company expects EBITDA margins to decline to the low-40s as it ramps up hiring activities in sales and marketing.
The company also continued to generate strong cash flows. Cash generation from operations rose to $130 million about a third of its revenues for the quarter. With the long-term growth trends of cloud computing, mobility and online video remain intact, we have a revised $45 price estimate for Akamai’s stock almost in line with the current market price.
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Demand for online video continues to grow
Revenue-wise, almost all of Akamai’s verticals, Media & Entertainment, Commerce, High-Tech and Public sector, grew strongly. Most of Akamai’s value (>70%), however, comes from the former two verticals, both of which are driven by web traffic growth and demand for online video. Internet traffic continues to surge, as social media, video streaming and online gaming grow at a frenetic pace. An increasing number of users are also accessing videos and other content from mobile devices such as smartphones and tablets. As a result, mobile data traffic is growing exponentially by almost 70% every year and is expected to grow 13-fold in the next five years, according to the most recent Cisco VNI report. Akamai, which delivers 15-30% of all web traffic, stands to benefit hugely from this surge in online traffic.
It is worthy of note here that halfway through Q1, Akamai had indicated that it would be winding down some media contracts which were not adding too much value. The wind-downs continued in Q2 as well with one large media customer fully transitioning its traffic away from Akamai. The fact that this had little impact on results which shows not only the fundamentals of the industry that Akamai operates in but also the diversity of its customer base.
Recovery in margins sustainable
The growth in online media streaming could have depressed margins due to the higher costs of delivery large video files and software but Akamai’s recent investments in its network have led to greater efficiency in content delivery. This helped gross margins improve by almost three percentage points over the same period last year.
What has also contributed to the gross margin improvement in recent times has been the increased adoption of value-added services. Value-added services (VAS) such as dynamic site acceleration (DSA), application acceleration, front-end optimization (FEO), security solutions 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 total revenues. As can be seen below, Akamai’s margins recovered in 2012 from the lows of the previous year, and we expect the recovery to continue in the coming years as CDN prices stabilize and VAS supports margins.
The strong performance of Akamai’s VAS portfolio, which has been bolstered by the spate of recent acquisitions such as Cotendo and Blaze, is helping it not only augment its core CDN business but also grab more wallet share of customers. The performance of security this quarter points to a recently added value-added service that is adding to the company’s growth. Akamai launched its Kona Site Defender security solutions last year and has already seen as many as 650 customers sign up for the offering, as of Q2. This is a 30% increase over the previous quarter. As a result, the company is also seeing ARPU levels improve since Kona has a comparatively higher ARPU than some of the other security solutions.