Akamai’s Ups And Downs

Akamai (NASDAQ:AKAM) witnessed many ups and downs in 2010. Early in the year, the company landed a deal with Netflix as a primary content delivery network, taking away business from Level 3. However, at the end of the year, Netflix, which accounts for about 20% of primetime Internet traffic, went back to Level 3. In December, Akamai also lost a court ruling in its four-year patent battle with Limelight Networks. Let’s take a closer look.

Wedbush analyst Kerry Rice said Akamai initially won the Netflix business on favorable pricing but decided that it wasn’t willing to cut a similar deal this time. Based on an analyst estimate, Netflix would have accounted for about $25 million in annual revenue for Akamai. If Akamai retains at least 20% of its business after this new development, it would still make close to $10 million from it or lose about $15 million annually. That is just a fraction of Akamai’s annual revenue. In 2009, Akamai had annual revenue of $859.8 million, and in 2010 it expects to hit its target of $1 billion in annual revenue.

Meanwhile, following its deal with Netflix, Level 3 is entangled in a commercial disagreement with Comcast. Level 3 has a peering agreement with Comcast but with more traffic expected, there is a disagreement over the price. For more details, read Stacey Higginbotham’s account of the events on GigaOM.

Tim Beyers on The Moteley Fool says that value-added services matter more to Akamai than its video business. These services account for more than half of its revenue and the majority of the company’s high-margin offerings. That is why in November, Akamai filed a patent infringement suit against startup Cotendo over its partnership with Google. Cotendo has a deal with Google to accelerate the delivery of cloud computing data. In its lawsuit, Akamai says Cotendo’s offerings are a little too similar to its own solutions. The recent Limelight case is its only failure. In December, Akamai lost its four-year patent dispute against Limelight Networks its patent related to CDNs. In 2008, Akamai had won $45.5 million in a jury verdict against Limelight that was set aside with the latest ruling.

While Akamai has experience dealing with legal maters, startup Cotendo could have some hassles. In 2000, Akamai successfully sued rival Digital Island, which was acquired by British telecom company Cable & Wireless in 2001 for $340 million. In 2005, Akamai acquired Speedera after suing it in 2002. Will Cotendo also be acquired? Its annual revenue in 2009 was $8 million.

Akamai’s Financials
Akamai in October reported third quarter revenue of $253.6 million, up 23% y-o-y and 3% q-o-q. Net income was $39.7 million or $0.21 per share, up 21% from $32.7 million, or $0.18 per share last year and up 4% from $38.1 million or $0.20 per share last quarter. Adjusted EPS was $0.34. Akamai ended the quarter with $1.2 billion in cash and repurchased shares worth $22.7 million. Gross margin was 69.3%, down two points from last quarter and down a point from last year.

With 26% y-o-y growth, Media and Entertainment remained its fastest-growing vertical for the second quarter in a row. E-Commerce revenue grew 24% y-o-y as it continued to add solutions targeting the mobile and online security markets. Public sector revenue was up 28% y-o-y. Revenue from the company’s high-tech customers grew 13% y-o-y, and it had increased demand for Application Performance Solutions from software-as-a-service customers.

Akamai said it expects fourth quarter revenue of $272 million to $285 million. The fourth quarter is typically Akamai’s strongest, but it is also the most impacted by the external macroeconomic environment. On a full year basis, Akamai expects to reach its target of $1 billion in revenue for the year. It expects full year revenue in the range of $1.01 billion to $1.02 billion, up 18% from last year at the midpoint, and normalized earnings per share of $1.38 to $1.41, up 15% at the midpoint. Akamai is trading around $49 with market cap of about $9 billion. It hit a 52-week high of $54.65 on December 8.

Personally, I am a huge fan of this company, and continue to hold the stock. My personal holdings on the stock already show a 35%+ gain, and I plan to hold on to it for the long term. Optimizing the Internet’s traffic will continue to be an essential piece of the equation. I would not be surprised if Netflix decides to come back to Akamai and ask for help in optimizing their streaming quality which is currently under tremendous pressure with increasing adoption. At that point, the bargaining power is with Akamai, and the price-point will simply settle at where they want it to. I expect a Netflix-Akamai deal in the future, for sure. No one other than Akamai has the kind of brain trust in the area on Internet traffic optimization.