Akamai Lowers Margin Target to Invest in Enterprise and Security

Akamai held an investor summit on March 30, 2017, delayed by about two weeks due to snow crippling the Boston area.  From a media business standpoint, Akamai reiterated that the overall business has continued to be healthy, despite big tech giants, such as Netflix, Amazon, and Facebook, that are building out their own content distribution networks (CDNs)  Akamai overbuilt somewhat on capacity in 2015, translating to  gross margins that fell a couple points, causing a slight easing up on investment in 2016. 

Akamai continued to grow its website performance business (Dynamic Site Acceleration and Ion products), no longer representing a simple object store-and-forward approach but instead, including several intelligent optimization technologies from image management to mobile-specific tools.  Further, Akamai realized that its position serving requests from the edge of the network allows it to rapidly deflect bot attacks prior to swamping the peering points and core network.  Akamai announced acquisition of SOASTA to close the loop on web performance measurement to web optimization.  Akamai’s security portfolio now contributes 16% (2016) of revenue for Akamai with a very strong growth rate (44% YOY growth).

Akamai’s overall top line revenue growth target is in the “low double digits” (i.e. 12-14%), which will be fueled a little by web performance, but more by the rapidly growing security products that are newer and not penetrated against the Akamai customer base, much less the entire industry.  In addition, due to some shift of product lines away from media to web performance, media now represents only 34% of Akamai revenues.  While media dominates from a “bits delivered” perspective, Akamai can no longer be thought of as a media delivery company.

One of the most interesting aspects of the investor summit is the management decision to reduce its net margin targets by investing more in both R&D and acquisitions, particularly web performance, enterprise security, and the emerging mobile business.  This market confidence was delivered along with a message highlighting to investors how undervalued Akamai management feels it is, specifically against a range of competitors including security vendors (FireEye, Check Point, Fortinet, Imperva, Palo Alto Networks), network infrastructure providers (GoDaddy, Interxion, Limelight, Equinix), and SaaS companies (Adobe, Salesforce, Citrix, F5 Networks, Redhat).    

Akamai is facing a media environment where it primarily serves smaller media distributors or those with more occasional needs, such as the Olympics and major sporting events, rather than fixed ongoing services, such as SVOD services.  In addition, large broadcasters in one market will likely find Akamai a great partner for international services.

Akamai has unique opportunities within the service provider market; however, it was disclosed that carrier related revenues (not including carrier sales channel) are only US$29 million.  This revenue line specifically refers to licenses of the Akamai Aura CDN to deploy within their own network for their owned video services.  This can be deployed as a managed or licensed option. 

Service provider relationships also include:

• Akamai hosts its CDN inside the carrier networks, a technical advantage compared to most other CDNs who host in colocation centers and are impacting by peering points.
• The service providers resell a host of Akamai solutions, including CDN and web performance and/or security solutions

The upcoming broadcast to IP transition within networks is another big opportunity for Akamai, which is expected to be a licensing business at much lower revenues (per bit delivered) compared to traditional CDN services. As service providers launch national services (such as AT&T’s DirecTV Now), they will have on-network and off-network needs.  Akamai is in a good position to accelerate the off-network delivery within other networks, including mobile networks.

Ultimately, to fully capitalize on both large internet companies and carriers, we believe that Akamai will need to get more aggressive with its intellectual property (IP) licensing around the CDN space to carriers.  Video companies, such as TiVo and Rovi (now combined), always relied heavily on IP licensing as a core component of the business. And recently, video software providers, such as Nagra, increased their focus on IP by signing agreements with Google and Netflix (2015), entering a strong product and license-based agreement with Samsung, and filing lawsuits against NFL Enterprises and Shaw Canada.

Akamai faces several strategic threats in media.  Do-it-yourself (DIY) has been highlighted as a concern for major video producers, but Edgeware recently commissioned a report showing that a private CDN could be cost-competitive at 100K subscribers within a small geographical footprint.  The merits of the claim likely are sound financially, although the applicability and wisdom will depend heavily on the operational capabilities of the service providers to manage a 24x7 service with quality of experience and accurately predict changes in demand.

Most of the major content owners and distributors are investing heavily in their owned media platforms.  Platforms such as Comcast Tech Solutions (CTS), the recent tie-up of Turner’s iStreamPlanet with NBC’s Playmaker Media, Disney and Discovery’s investment in BAMTech, and Verizon’s Digital Media Solutions (VDMS) are well known and have recently gotten additional branding or new investment.  However, the Japanese networks are similarly investing in a domestic CDN for their shared content, JOCDN.)

At some level, Akamai’s description of itself at the intersection of SaaS, security, and infrastructure is accurate; however, we see them more clearly as a cloud-based vendor.  Specifically, the cloud requires three major components: computing, storage, and networking (delivery).  Akamai provides a very small amount of compute, generally accessible only within a narrow set of API-driven functions, such as video transcoding.  Akamai provides a good amount of storage through NetStorage.  While it is a bit under-publicized, it is increasing in utilization by customers and provides an alternative to externally hosted origin servers with Akamai just playing the role of a CDN.  Of course, Akamai provides a very large percentage of CDN delivery, including for competitor Microsoft Azure. 

Therefore, we think it’s equally fair to consider Akamai a cloud competitor.  Akamai’s current diversified strategy of growth–extending product lines where a good network/technology integration can be performed, and where customer synergies exist–is very well founded.