CDN Market Trends

Content delivery network (CDN) market leader Akamai (NASDAQ:AKAM) has long charged a premium for its services, and rivals such Level 3 (NASDAQ:LVLT) have survived by being much cheaper. However, over the past quarter Akamai has been very aggressive in its prices, matching those of its rivals and sometimes undercutting them. The CDN market is crowded with about 50 vendors, but only four of them have revenues that exceed $50 million. Analysts expect the number of vendors to fall dramatically over the next two years.

Akamai has traditionally offered strategic discounts to large customers. But now it is aggressively reducing its prices across more of its services to capture additional market share. Dan Rayburn points out that Akamai has to reduce its pricing to be about 15%-20% more than its rivals to win a contract. But even that would be a drastic reduction for Akamai, which currently charges about 200%-250% more, and it is bound to affect the company’s margins. Akamai must therefore hope to compensate the price reduction with increased traffic volume. Looking at the tremendous growth of Web traffic, Akamai would still stand to make money, but perhaps not as much as before. However, its rivals will likely find it tough to play the game unless they match Akamai’s superior technology. I doubt that many of the smaller vendors will be able to sustain themselves.

Another trend in the CDN market is the entry of telcos and carriers. Most have gone via the partnership or reselling route, while Level 3 is the only one that operates its own network. This strategy has helped the company to gain some market share — it managed to cross the $50 million mark within two years while Limelight Networks took three years to do so. Dan Rayburn says that the secret behind much of Level 3’s success lay in its CDN business being treated as a separate startup entity, which allowed it to respond faster to the market. However, Level 3 recently announced some restructuring plans and changed the management team of the content market group. This has raised doubts among customers about the successful integration of its CDN business, causing the company to lose some of its momentum.

Let’s now take a look at the recent performance of Akamai, its rival Level 3, and Alcatel-Lucent (NYSE:ALU), which in August entered the CDN market with its acquisition of UK-based Velocix. Last quarter’s coverage of the three companies is available here.

Early this month, Akamai reported a strong fourth quarter with a return to double-digit growth. Revenue in 2009 grew 9% to $859.8 million and net income for 2009 was $145.9 million, or $0.78 per diluted share. Q4 revenue grew 12% y-o-y and 15% q-o-q to $238.3 million driven by new contract signings of over 200 and a 9% increase in recurring service contract customers to over 3,000. Q4 net income was $40.1 million, or $0.21 per diluted share.

Akamai repurchased shares for about $15 million during the fourth quarter and $66 million in the full year. It ended the year with over $1 billion in cash. Gross margin was 72%, up two points from Q3 and up one point from Q4 of last year.

For the first quarter, Akamai expects revenue of $224 million to $233 million versus analyst estimates of $228 million. For 2010, the company is targeting double-digit revenue growth — back in 2006, its revenues grew about 50%. But the increasing competition and the recession have impacted its growth rate. The stock is currently trading around $25 with market cap of about $4 billion. It hit a 52-week high of $27 on January 14.

Level 3, Akamai’s main rival, last week reported Q4 revenue of $924 million, down 12% y-o-y, and a wider-than-expected loss of $182 million, or $0.11 per share, compared to net income of $43 million, or $0.03 per basic share, last year and loss of $170 million, or $0.10 per share, last quarter.

For 2010, the company said that it is still cautious about the impact the economy will have but also believes that it is the right time to increase its investment for growth. Level 3 plans to expand its sales force and sales support operations and expects its operating expenses to rise in 2010. The stock is currently trading around $1 with market cap of about $2 billion. It hit a 52-week high of $1.77 on June 11 of last year.

Alactel-Lucent last week reported its third straight full-year loss but managed to post a small profit in the fourth quarter. Since the 2006 merger of Alcatel with Lucent, the company has struggled to make a profit, and now with the new CEO, Ben Verwaayen, who took rein at the end of 2008, it has finally had a little success. The company is now hopeful of a full-year profit in 2011.

Q4 revenue was €3.97 billion ($5.4 billion), down 20% y-o-y and up 7.6% q-o-q while net profit was €46 million ($62.61 million) or €0.02 ($0.27) per share. Despite two profitable quarters of Q2 and Q4, Alcatel-Lucent reported a loss of €524 million ($713.21 million) or €0.23 ($0.31) per share for the full year. Revenue in 2009 was down 10.8% to €15.57 billion ($21.19 billion). Alcatel-Lucent cut €950 million ($1.30 billion) in costs last year and ended the year with a net cash position of €886 million ($1.21 billion).

For 2010, Alcatel-Lucent continues to expect nominal growth between 0% and 5% for the telecommunications equipment and related services market. It was recently selected by AT&T as a key supplier for long-term evolution (LTE), a high performance air interface for cellular mobile communication systems.

The stock is currently trading around $3 with market cap of about $6 billion. It hit a 52-week high of $4.69 on October 7.