Coverage of the shares of this tech company were recently initiated at RBC Capital with an ‘Outperform’ rating.
Akamai Technologies, Inc. (AKAM)
From Investor Advisory Service
The early days of the Internet were plagued with slow response times and website usage failures as networks strained under the weight of growing demand and emerging bandwidth-hungry applications like video streaming. To alleviate bandwidth issues, firms would move their applications to computer servers located near customers to speed up response times.
Initially these servers were run by the firms themselves. The problem with this approach was the high cost of installing and running data centers and the complexity of managing the network. Akamai Technologies, Inc. solved this problem by inventing the world’s largest Content Network Delivery (CND) architecture. The Akamai network service runs customers’ applications near the point of contact for the user, often called the “Edge” of the Internet. Akamai’s network comprises 325,000 servers in 4,100 locations within 130 countries, and interfaces with over 1,400 networks that support user connections.
Akamai’s customers include a large percentage of the world’s most important brands, including hundreds of media companies, online retailers, governments, financial institutions, and other enterprises. Global brand name customers include Adobe, eBay, Fidelity Investments, Honda, NBCUniversal, PayPal, Spotify, and Viacom. Public sector clients also use the service, including the Federal Aviation Administration and U.S. Department of Defense. No customer accounted for greater than 10% of revenue during the past three years.
CND delivery solutions are optimized by customer and fall into two categories: Web and Mobile Performance Solutions (Web) and Media Delivery Solutions (Media). Web customers, particularly those supporting eCommerce transactions, value instant response times to websites and applications regardless of the type of connection, device, or browser. Media customers, particularly those supporting online gaming and streaming of movies, television, and live events, not only value instant, reliable access but appreciate bandwidth usage strategies that reduce cost and alleviate network congestion. Web customers accounted for 52% of 2020 revenue and have grown 8.5% on average over the past three years. Media customers have grown slightly faster, 9% per year, heavily influenced by the burst of growth in 2020 as customers sheltering in place turned to streaming services for entertainment.
In the first decade of the 21st century Akamai posted top-line sales growth in the double-digits. However, the past 10 years have seen growth slow to the upper single-digits, largely due to slower growth in the mature U.S. market. The company indicates it wants to return to double-digit growth and has several strategies to do so.
The global growth of the Internet should continue to support international opportunities. Over the past five years, international revenue has more than doubled, growing 19% per year and now accounting for 44% of total revenue. As Akamai continues to add new server locations in response to user growth, the network becomes more attractive as a way for companies to reach the largest possible user base.
Another growth driver for Akamai is the need for customers to fight security threats such as malware, distributed denial of service (DDoS) attacks, non-human (bot) users, and ransomware. To emphasize the growing importance of security, Akamai reorganized its marketing and development teams into two groups in early 2021: the Security Technology Group and the Edge Technology Group. The Security Technology Group, about 38% of 2021 YTD revenue, has grown 27% this year and in the long term is expected to make up more than 50% of total revenue. Only 67% of current customers have purchased a security offering, leaving plenty of room for additional business. Further, the nature of ever changing cyberattacks creates the opportunity for new, stand-alone cybersecurity offerings that can generate incremental revenue.
Media streaming should drive significant bandwidth growth. Today, even though 50% of all Internet bandwidth usage is media streaming, only 20% of viewership is streamed over the Internet versus 80% for television. Akamai should continue to get a boost from newer streaming services like Disney+, HBO Max, and Comcast’s Peacock, all of which are customers.
Acquisitions should also contribute to Akamai’s growth, particularly in the Security Technology Group. In October the company closed on the purchase of Guardicore, a company focused on Zero Trust security solutions that are highly effective at detecting and preventing network intrusions. Zero Trust is very important for mounting ransomware threats that are costing businesses both the money needed to pay off the criminals and lost business when websites aren’t available.
Akamai’s shares are not inexpensive, but the firm’s recurring revenue model and sticky customer relationships provide some downside protection. Further, the company generates substantial cash flow that it uses to repurchase shares. In November, Akamai added $1.8 billion to its existing share repurchase authorization that had $321 million remaining.
Analysts are projecting 12% average annual long-term earnings growth. Five years at this pace and a future high P/E of 35.8 could generate a stock price as high as 230. We calculate a low price of 77, the combination of trailing twelve-month EPS of $3.64 multiplied by the five-year average low P/E of 21.3. The upside/downside ratio is 3.9 and compounded annual total return of 16.1%.
Doug Gerlach, InvestorAdvisoryService.com, 1-877-33-ICLUB, December 2021