Written by David Dixon of FBR Inc; edited by Alan J Weissberger, IEEE ComSoc Content Manager.
NOTE: Akami March 8th update in II. below.
I. Summary for PDVW:
Pacific Data Vision Wireless (PDVW)’s pending 900 MHz rebanding application is progressing in line with company expectations. Management has requested a meeting with the FCC next week to seek an updated understanding of the current status of the application and to provide details of additional industry support. We believe the timing is fortuitous: We think it coincides with work completed on the application by the FCC. We view the upcoming meeting as a positive step towards a Notice of Proposed Rulemaking (NPRM).
We are not privy to the details of current discussions with industry incumbents, due to non-disclosure agreements in place, but we believe significant progress has been made over the past six months. While a consensus industry position is positive, with so many incumbent users, we do not think the FCC sees this as necessary to move forward with an NPRM. In cases such as PDVW’s, where many parties are involved and consensus is difficult to achieve, we believe the FCC is more likely to weigh the petition’s benefits and make a determination. We have greater confidence in a positive outcome in the short term.
■ Upcoming FCC meeting. PDVW’s management will be meeting with the FCC next week. We believe this is an opportunity for management to showcase positive progress being made with incumbents, as well as to seek an updated view of the FCC’s current thinking, which, we believe, will be positive.
■ New spectrum acquisition. PDVW has acquired additional spectrum (~100 channels) for an average of $0.17/MHz/PoP. The licenses are in markets where PDVW’s channels are fewer than the average of other markets. While the price was higher than the $0.06/MHz/PoP paid to Sprint, these licenses are in 10 of the top markets, which warrant a higher price and are below market value, in our view. Management has been moving cautiously with regards to how much it is willing to pay for spectrum.
■ Slower PTT buildout. Management paused more market launches due to a slower ramp-up in its initial eight markets, similarly to what Nextel experienced early on.
(1.) Certain site developments are taking longer (zoning, rent negotiations, etc.), but the Chicago/ NYC/ Philadelphia /DC/ Baltimore markets should be fully operational by the end of April.
(2.) Despite positive customer feedback, third-party dealer sales have lagged; some dealers prefer to wait until the network build is completed and tested. In response, management has encouraged the hiring of dedicated sales reps. While it will take time to work out distribution issues, regulatory developments are the driver of PDVW shares, in our view.
Can Pacific DataVision fast track the FCC approval process to further enhance spectrum value?
Answer: If FCC approval to convert Pacific DataVision Wireless’ narrowband spectrum to 3 MHz x 3 MHz LTE occurs faster than expected (before June 2016), it could be a big positive for the company. Furthermore, if Pacific DataVision is successful in acquiring 80% 90% of the existing spectrum band from incumbent operators, it should provide additional flexibility, which should be accretive to valuation.
We do not believe Pacific DataVision is at risk of changes in the spectrum supply curve for capacity spectrum (>2 GHz), given that its spectrum is in the low band and this remains a scarce asset. We believe extra spectrum capacity can be leased in location-specific pockets in each region to serve corporate demand for private LTE networks. Moreover, if Pacific DataVision raises capital to acquire additional spectrum, this could provide increased synergies, revenue upside, and time-to-market advantages for the existing business and should be accretive to our valuation and price target. Management s past success at Nextel, industry knowledge, reputation, and experience with 800 MHz SMR spectrum rebanding are key.
In contrast to capacity layer spectrum (>2 GHz), we forecast increasing value of coverage layer spectrum (<1 GHz) due to:
(1) the strategic nature of this spectrum as the lowest-cost source of spectrum for wide coverage areas,
(2) the relative scarcity of this spectrum asset, and
(3) attractive comparables.
The recent H block auction won by DISH valued higher-frequency spectrum at $0.61/MHz PoP for 5 MHz x 5 MHz of 1.9 GHz spectrum in the top 20 markets. AT&T Inc. spectrum acquisition from QUALCOMM Incorporated valued low-frequency spectrum at $0.91/MHz PoP.
II. Akamai Techologies Inc. Solid 4Q15 Results; Weak 1Q Outlook: Secular Challenges Are Growing:
NOTE: Akami March 8th update below the Feb 10th earnings report analysis.
On Feb 10, 2016, Akamai Technologies Inc. (AKAM) announced solid 4Q15 earning/revenue results and a new $1B share repurchase program. Revenue for 4Q was modestly above Wall Street estimates, driven by double-digit growth in the performance and security and the service and support solutions segments. The media delivery solutions revenue decline of 1.8% YOY was better than feared. Weak 1Q16 guidance is driven by aggressive pricing and revenue declines from its top two customers (13% of revenue, heading to 6% by mid 2016) as they migrate to “do it yourself” (DIY) platforms.
We see greater DIY (and repricing) risks in the CDN business as foundational data center and fiber assets are established for more players today than in 2011, providing low incremental cost opportunity. An intense sales focus has the performance and security solutions business ramping nicely, but we see secular challenges with the enterprise segment bifurcating. Specifically, we see more migration to cloud platforms, which is likely to confine AKAM to a reduced (partnership based) role for companies’ CDN, Web security, and enterprise security needs. A major enterprise security acquisition is necessary to mitigate the risk of a value trap, but this appears unlikely with management favoring the benefits of superior cash flow.
Will sales force investments and international expansion pay off?
Akamai continues to accelerate investment in its sales force. Most of the company hiring will be done with a focus on international, where the company believes the revenue opportunity could one day equal North America. We think that the growth seen in international revenue supports the company decision to aggressively expand sales capacity and that the move could ultimately pay off.
Can newer products contribute enough to offset maturing core markets and drive sustained midteens, or better, growth?
Akamai s focus over the past few years has been to increasingly diversify its business beyond media delivery and Web performance. Through acquisitions and investments, the company entered new end markets and doubled its addressable market. Akamai s newer product groups Web security, carrier products, and hybrid cloud optimization are growing well, but overall growth is still determined by performance in Akamai s slowing core markets. These businesses are achieving scale, but the rate of slowing in the core CDN business is occurring faster than expected, and the magnitude and timing of OTT opportunities are unclear.
Will Akamai s business model be pressured over time by the irreversible mix shift of Internet traffic toward two-way increasingly distributed on cloud-based architectures that provide compute and storage?
While the amount of Internet traffic is growing, there is an increase in DIY CDN business, and the amount of static, Akamaicacheable data on the Web is falling as a percentage of the total amount of data with which customers interact. In 1999, the Web was a read-only medium with very little user-generated content, customization, etc. Today, the flow is much more bidirectional (and therefore uncacheable). We do not see that Akamai has a play here; it may resist this architecture shift, as moving into these growth areas would likely cannibalize the CDN revenue base. More acquisitions to enhance the enterprise security portfolio in the interim are likely as the company continues to diversify away from the commodity CDN business segment. Yet the market has responded to the unification of software accessing three types of storage by moving toward distributed, layered IaaS/PaaS systems (e.g., Amazon Web Services aka AWS) using HTTPS APIs (versus FTP), providing compute and storage (versus caching of object storage). Improved performance, reliability, and scale are occurring fast, and we expect many cloud customers that are not scaled up will still require a CDN for performance enhancement.
We believe Akamai Technologies is in transition as its core media delivery business matures. The company has stepped up its diversification efforts, including (1) broadening the product set, (2) ramping sales hiring, and (3) expanding internationally. The long-term impact of these efforts could be a positive, but we see increased pressure on Akamai’s CDN-based business model over time, driven by the irreversible mix shift of Internet traffic toward “two-way” content increasingly distributed on cloud-based architectures that provide compute and storage. We view the risk/reward at current levels to be negative, as near-term positive momentum is more than offset by fundamental challenges in the CDN segment.
March 8, 2016 Update after David Dixon’s attended Akamai’s Annual Investor Conference:
“We saw nothing to allay our concerns regarding greater do it yourself (and repricing) risks in the CDN business as foundational datacenter and fiber assets are established for more players today than in 2011, providing low incremental cost opportunities to deploy distributed compute platforms via technology partnerships with key vendors.
An intense sales focus has the performance and security solutions business ramping nicely, but we see secular challenges with the enterprise segment bifurcating. Specifically, we see more migration to cloud platforms, which is likely to confine AKAM to a reduced (partnership based) role for these companies’ CDN, Web security, and enterprise security needs.
A major enterprise security acquisition is necessary to mitigate the risk of a value trap, but this appears unlikely with management favoring the benefits of superior cash flow.”
III. CDN Competitor Limelight Networks, Inc. (LLNW):
LLNW’s improvement in profitability highlights management’s focus on improving the company’s cost structure, including head-count reductions (down 47 heads sequentially), efficient infrastructure (fewer servers and racks), and software changes to improve server capacity. While 4Q traffic declined sequentially, the average selling price increased due to increased streaming traffic from higher-paying customers who demand higher quality and reliability of service. Holiday season traffic hit another record during the quarter. Management believes revenues will increase in 2016, driven by traffic increases, but partially offset by the expected continued decline in average selling prices. In the face of further commoditization and low barriers to entry, it becomes imperative for LLNW to find ways to grow the top line, as cost cutting may not be sufficient to sustain profitability, in our view. LLNW’s ability to maintain a positive revenue growth trajectory is still unclear.
Downward pricing pressure and competition will continue to be the primary variables in the commoditized high-volume content delivery market. Pricing continues to be an issue in the industry, although there has been more stability in recent quarters.
Will CDN competition and pricing pressure worsen?
Limelight’s decision not to renew some uneconomic contracts has been a headwind for CDN revenue. Should pricing worsen, there could be even more pressure on the CDN business. In general, we believe competitors will maintain price discipline due to rising peering costs and that predatory pricing for market share gains is abating; this should allow pricing to stabilize again at a better level over the long run. We think solid volumes should be able to offset at least some of the headwinds from pricing pressure. 6 to 12 Months
How long will it take Limelight new management team to return the company to growth?
While the company has established a strategy for its turnaround, we believe this will be a multi-quarter process and that shares could be range bound until signs of improved execution or growth appear. The transition has faced some bumps already, and this could continue. We believe the company goal of stabilizing the CDN business and achieving growth through the VAS business could work, but it will take time before we start to see the impact in fundamental results. Management needs to post consistently positive results to combat concerns that pure CDN players are at risk from the combination of:
(1) increased competition for a commoditized service,
(2) higher customer churn,
(3) technology risk from HTTP 2.0 and SPDY (which significantly improves Web site latency),
(4) higher peering interconnection costs, and (5) CDN functions increasingly being deployed by content and end-user networks.
Will Limelight be acquired?
While the likelihood of a near-term takeout is lower, in our opinion, due to the recent management changes, we still consider Limelight to be a valuable strategic asset for a number of potential suitors. Specifically, we think a large telecom services company, content provider, or peripheral communications company could potentially make a bid for Limelight. At LLNW current valuation, we think the option of buying versus building has become more attractive for a strategic buyer.
With new management on board and a plan to invest for growth in the out years, the near term, we believe, is setting up to be a transition period for the company. It remains to be seen what will unfold.