Akamai: Long-Term Value Underpinned By Short-Term Upside And Strong Fundamentals

In many ways, Akamai Technologies (NASDAQ:AKAM) is a backbone component of Internet content delivery as we know it today. With over 300,000 servers spanning 130 countries, 4,000 PoPs (Points of Presence), and 1,500 networks, it is one of the most expansive edge networks available to modern businesses looking to have their content and data delivered rapidly and securely to users across the world. It hosts content and applications for more than half of all Fortune 500 companies, and its clients straddle multiple industries, ranging from banking to retail to gaming to advertising and more.

Thesis: As a segment leader in a fragmented market and boasting a vast physical presence, Akamai offers long-term value due to its current growth metrics, strong financial position, and a positive outlook for the edge computing services market.

A Dominant Presence

In spite of heavy competition from newer, niche players, Akamai continues to dominate the content delivery space in several areas. As of Q2-20, it commanded over 87% of the media delivery solutions market and over 81% of the service support solutions market. In terms of total segment market share, Akamai holds a 4.5% share of the overall content optimization, delivery, and security market.

As a pioneer in edge computing and serverless technologies, Akamai boasts the largest programmable edge in the world – the Akamai Intelligent Edge Platform – with enviable related IP: roughly 20% of the company’s 400+ patents cover innovations in edge computing. In addition, revenues of $2 billion were generated from edge computing solutions for the 12 months ending June 30, 2020, per a company blog post. Its edge computing solutions span a range of use cases in cutting-edge technologies, as shown in the table below:

Source: Akamai Blog

With its expansive fingers in so many future-friendly pies, Akamai is well positioned to keep growing over the next several years. That brings us to recent growth trends and indicators for future growth.

Recent Growth Trends and Future Growth Indicators

Despite being a leader in several segments within content delivery and application hosting, the company has managed to keep showing straight-line revenue growth over the past several years. Over the last decade, the company has nearly doubled its revenues even though smaller competitors like Fastly (FSLY) have been growing aggressively during that time.

In Q2-20, Akamai’s revenues grew by 12.7% to nearly $800 million over Q2-19. For H1-20, the revenue growth rate stands at over 10% over the prior period. On a TTM basis, revenues grew 8.8% between June 2019 and June 2020. This shows increasingly strong growth in spite of fast-growing competitors.

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Source: Seeking Alpha Charting

At the bottom line, the company has been showing impressive growth for its scale and size. Although TTM earnings growth was relatively flat until mid-2018, since then, it’s grown by more than 150%. In the past three years, the stock price has more than doubled, indicating strong price return momentum. Despite this, and the fact that the company is posting +20% net income margins as the bulk of its competitors continue to post net losses, the stock is still trading at forward non-GAAP earnings ratio of around 22, which is well below the sector median of around 27.

In the short term, the company expects Q3-20 revenues of $760 million to $785 million, or 7% to 11% over the prior period on a constant-currency basis. Diluted non-GAAP EPS is forecasted at $1.20 to $1.24, representing a growth rate of between 8% and 12% over the prior period on a constant-currency basis.

For FY-20, the company has guided for revenues of $3.125 billion to $3.175 billion, which includes $1 billion in revenues from the Cloud Security Solutions unit. The segment brought in revenues of $499.6 million for H1-20, representing a 26.5% increase over the prior period’s revenues of $394.9 million. The growth was primarily driven by elevated media traffic volumes due to the COVID-19 outbreak, and we should be able to see some sustained gains during the back half of the year.

These growth estimates are quite conservative. The security business, in particular, is something to be watched as the business world shifts to the work-from-home model. With most companies adopting this model for the long term, for at least part of their workforce, the need for security will keep growing as edge usage keeps growing.

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Source: DoubleVerify via Forbes

In addition, media consumption is at an all-time high. The key drivers of that growth are not just pandemic-related but also the sheer body of content that’s being published, uploaded or streamed on a daily basis across news media sites, social media platforms, streaming portals, online gaming sites, advertising networks, etc.

Akamai’s expansive presence around the world makes it an easy choice for content producers and other companies that deliver content in terabytes and petabytes. Today’s buzz-phrase is “user experience”, and that’s the broader market Akamai addresses with its products.

Financial Position

From a financial standpoint, Akamai looks to be in good shape. Current ratio as of Q2-20 was around 3.34, and its cash, cash equivalents, and marketable securities give the company adequate liquidity to address its capex, IT investment, acquisition and other requirements, as well as keep servicing its debt obligations, which primarily comprise convertible notes due in 2025 and 2027. Akamai had long-term debt commitments of around $1.9 million as at June 30, 2020, with a relatively conservative debt to equity ratio of about 0.48.

Investor’s Angle

I consider Akamai to be a relatively stable investment in edge computing because of the fundamentals as well as the long-term prospects for the edge computing market as a whole. The market is expected to grow at much faster rates moving forward:

MarketsandMarkets projects the global edge computing market to grow from USD 3.6 billion in 2020 to USD 15.7 billion by 2025, at a Compound Annual Growth Rate (CAGR) of 34.1% during the forecast period. Factors such as growing adoption of Internet of Things (IoT) across industries; rising demand for low-latency processing and real-time, automated decision-making solutions; and a need for surmounting exponentially increasing data volumes and network traffic.

Specific to Akamai, there’s near-double to double-digit growth expected at the top for this year, while margins are healthy and earnings over the past few years have been growing at double-digit rates. As the world moves toward greater automation and the number of edge devices exponentially increases over the next decade and beyond, companies like Akamai stand to make significant top-line gains. The company already has achieved economies of scale, which is showing up at the bottom line. Moreover, Akamai continues to invest heavily in capex (22% to 23% of FY-20 revenues) and R&D (13% to 14% of revenues.) This is one of the things that will keep it relevant in the years ahead.

In terms of valuation, we’ve already seen that the stock is trading at a discount to the sector median. This indicates some hidden upside that the market hasn’t yet priced into the stock. Analysts on WSJ have a 12-month median price target of $126.50, representing a 12% upside as of this writing. As such, there’s definitely a lot of long-term value in this stock at the current price.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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