FBR Telecom Services: Akamai Earnings Report Analysis; Q&A

by David Dixon, FBR & Co.

Overview:

Facing lofty expectations, CDN leader Akamai (AKAM) delivered solid 4Q16 results that beat consensus’ estimates. The performance and security solutions segment again achieved double-digit growth: 16.7% YoY.  Consolidated revenues were $616.1M (+6.44% YoY).

However,  guidance for elevated CAPEX and an EBITDA (Earnings Before Interest, Taxes, Depreciation, Amortization) margin contraction in the securities products segment was a surprise.

AKAM management is in a race to gain market share as quickly as possible in this fast moving, but high-growth, segment. The bulk of securities growth has come from the installed base. As the largest Internet platform customers’ revenue contributions diminish, management needs to expand the securities base to replace lost media delivery revenues.

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Q&A:

1.  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.

2. Can newer products contribute enough to offset maturing core markets and drive sustained mid-teens, 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.

3.  Will Akamai s business model be pressured over time by the irreversible mix shift of Internet traffic toward twoway 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., 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.

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