AKAMAI TECHNOLOGIES INC AKAM S
May 15, 2017 - 12:56am EST by
u0422811
2017 2018
Price: 49.43 EPS 2.52 2.62
Shares Out. (in M): 175 P/E 0 0
Market Cap (in $M): 8,685 P/FCF 0 0
Net Debt (in $M): -938 EBIT 0 0
TEV ($): 7,747 TEV/EBIT 0 0
Borrow Cost: General Collateral

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Description

Akamai Technologies ("AKAM") provides services for accelerating and improving the delivery of content and applications over the internet.  For those who are familiar with CDNs and the plumbing of the internet skip ahead to the end.  For those who aren't - let's boil this down to the simplest elements.

 

What does AKAM really do?  They basically have two main businesses.

1) Delivering Content

2) Protecting Websites

 

Business #2 is fine and growing nicely – but is a crowded market and faces tough competition from a wide range of cybersecurity firms.  Business #1 is the bulk of AKAM's business and nearly all the profits.  Business #1 was built in the early days of the internet. 

 

To understand why business #1 is in trouble let's use this analogy.  To understand the plumbing of the internet the obvious analogy is well....real-world plumbing (go figure!).  Way back yonder every house on the old farm had its own well.  AKAM effectively existed to pump the water from the local well into the old farmhouse.  As society evolved (and the internet) houses stopped drilling their own wells and hooked up to city water.  So now all of the pumps that AKAM used to push water to your home from the well don't really make sense as you now have access to far wider industrial grade pipes directly to your home (fancy city water).  Further - more companies started to make pumps as water is a necessity and people would pay up for this so the pump business turned out to be fairly lucrative.  While each house still needs water, there are now far more options on how to get it, resulting in a lower friction process that costs less (i.e. less profits in pumping).  The Farmer wants consistent water to his house so he can live.   Now here is where our analogy gets a bit messy - AKAM's pumps were only built with one direction in mind - getting the water from the well to the house, not the other way around.  As the world has moved to a kumbaya green society each house now has rain collection reservoirs that cleans and pumps that water back into the system. Houses are now getting flooded with water and the existing piping does not help alleviate that flood (aka the CDN business is optimized for delivery out not protecting in).  Another bad analogy could be the chef's knife is very good for general purpose cutting, but it is a terrible tool for peeling carrots or removing fish scales. A special tool is required for both these tasks.  To sum it up Billy Madison fashion: So, you see, the house was like AKAM's POPs. As the internet evolved the POPs got lost in the woods. And nobody, especially the little farmer - "society" - knew where to find 'em. Except that AKAM is a secularly challenged business. But the internet, my friends, that was a revolution. 

 

What follows is my short pitch on AKAM.  Similar to Billy Madison there is a chance that what I am about to say is one of the most insanely idiotic things you readers may ever hear, and at no point in my rambling, incoherent response may I be even close to anything that could be considered a rational thought and everyone on VIC will now be dumber for having listened to it.  But given we are already observing this change and all my diligence continues to point towards it I fell confidence.  If not, I will be awarded no points, and may God have mercy on my portfolio.

 

AKAM is a secular short as their core business is being commoditzed as the evolving internet architecture has eroded their primary moat.  AKAM's main bread and butter is operating a CDN network that helps consumers by caching data across the global network.  AKAM built its network when width mattered - as the internet architecture has changed this (moved from width to depth) this has resulted in commoditization - failing prices and margins. 

 

You have already seen the cracks in AKAM's media business as media pricing has fallen by 20%+ for the last 7 years.  What has kept the SS AKAM afloat is the strong growth and margins in the performance & security division.  AKAM's performance and security division's gross margins are something like 2.5x what they achieve on media delivery solutions.  Media delivery is shrinking topline by high single digits.  Performance and security has been growing by low double digits.  The problem with this is a growing market with 80%+ gross margins has quickly attracted competition and as AKAM's core business is erroding they have moved into other areas.  AKAM is going after higher margin areas like performance and security and AMZN and others are also targeting those areas which will whittle away the margins.  We will see exactly what happened with media CDN replay in the performance and security (for frame of reference media CDN went from a 60% margin business to something closer to 30% over the span of three years).  Why is this happening now?  Well CDN has become a commodity and as providers (AKAM, Fastly, Verizon, Amazon, etc.) have mastered this area they are slowly moving up the value stack.  Speaking with customers we are already seeing the price point for value added services beginning to drop - you even saw this in the weak guidance and numbers from AKAM in the last quarter.  To make matters worse within the market AKAM is charging 2x-3x what others are charging.  AKAM now competes for about 75% of its web performance business and that number is rapidly growing. A good example of this was the NY Times was a AKAM shop and tried to leverage them for more advanced services and immediately regretted it.  This introduced a lot of complexity and cost and was not valuable.  What ended up happening is the NY Times shifted over to Fastly which was drastically cheaper and introduced a standardized interface that was extremely user friendly.  When old media calls your product clunky and your tech commoditized that is usually not a good sign.

 

The one supposed saving grace for AKAM is security.  AKAM offers a very basic DDOS and WAF.  They will likely dive further into the security stack to diversify away from rapidly commoditizing assets.  The problem with this is DDOS and WAF are the extreme low hanging fruit in cybersecurity (fairly commoditized themselves) and the further AKAM tries to poke its head in this market the more likely it is to run into a big boy.  Further you can't just cobble together new services on AKAM and hope they will work.  AKAM is not too dis-similar from Blackberry - a decade ago it was cutting edge for large file object delivery but when you ask it to do something else (surf the internet, load balance, or DDOS) then you start to see the scare tissue that has built up.  AKAM is often now bumping heads against IMPV in the market.  IMPV's inability to sell itself shows how attractive that underlying market really is in the eyes of the industry.  Cyber security is too small a segment for AKAM right now to be meaningful and the only chance AKAM has of making a big splash would be a large and dilutive acquisition.  Something I think CEO and Co-FOunder Tom Leighton is incapable of doing. 

 

The other bull hope is that 4K streaming will become so huge as to override any declines in media pricing.  This is not happening.  Further there are mass usage issues that will prevent this - no one is streaming in 4K because: 1) they can't and 2) most streaming media is consumed on a form factor that makes 4K a waste of time.  The difference between HD and 4K on your cellphone is pretty undetectable and streaming media companies know this so they are not rushing to spend oodles of dollars for zero benefit. 

 

As AKAM's performance business starts to commoditize you will see topline slow and margins drop.  This will culminate with AKAM's multiple dropping.  You have a company that is growing topline in the mid single digits and in FY18 Adj EPS (since they do a large amount of massaging between GAAP and Adj) is going to grow at low double digits.  People will eventually see AKAM for what it is - a legacy piece of tech and will apply an appropriate multiple.

 

AKAM is also attractive as a short since it hash little to no risk of getting bought out.  Now large tech company would want them as most can do it in-house (all do in fact except MSFT farms it out since they view CDN as low value-add).  Earnings will continue to disappoint as pricing and margins drop accordingly.  I would not be surprised to see this slowly sink down to the $30s (roughly 15x my 2019 Adj EPS).  There are not many outs AKAM can do - you can try and repurchase as much stock as you like but that won't change dying topline growth and decaying margins.  

 

Finally - Knibb High Football Rules! (Apologies to those who are reading this and are unfamiliar with the classic piece of cinematic canon that is Billy Madison).

I do not hold a position with the issuer such as employment, directorship, or consultancy.
I and/or others I advise do not hold a material investment in the issuer's securities.

Catalyst

In the short-run, the Streaming Media summit should have some announcements from Google and AMZN that are not helpful to AKAM.  In the long-run, each quarter competition will continue to drive pricing lower and take larger chunks of market share.  

 

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    Description

    Akamai Technologies ("AKAM") provides services for accelerating and improving the delivery of content and applications over the internet.  For those who are familiar with CDNs and the plumbing of the internet skip ahead to the end.  For those who aren't - let's boil this down to the simplest elements.

     

    What does AKAM really do?  They basically have two main businesses.

    1) Delivering Content

    2) Protecting Websites

     

    Business #2 is fine and growing nicely – but is a crowded market and faces tough competition from a wide range of cybersecurity firms.  Business #1 is the bulk of AKAM's business and nearly all the profits.  Business #1 was built in the early days of the internet. 

     

    To understand why business #1 is in trouble let's use this analogy.  To understand the plumbing of the internet the obvious analogy is well....real-world plumbing (go figure!).  Way back yonder every house on the old farm had its own well.  AKAM effectively existed to pump the water from the local well into the old farmhouse.  As society evolved (and the internet) houses stopped drilling their own wells and hooked up to city water.  So now all of the pumps that AKAM used to push water to your home from the well don't really make sense as you now have access to far wider industrial grade pipes directly to your home (fancy city water).  Further - more companies started to make pumps as water is a necessity and people would pay up for this so the pump business turned out to be fairly lucrative.  While each house still needs water, there are now far more options on how to get it, resulting in a lower friction process that costs less (i.e. less profits in pumping).  The Farmer wants consistent water to his house so he can live.   Now here is where our analogy gets a bit messy - AKAM's pumps were only built with one direction in mind - getting the water from the well to the house, not the other way around.  As the world has moved to a kumbaya green society each house now has rain collection reservoirs that cleans and pumps that water back into the system. Houses are now getting flooded with water and the existing piping does not help alleviate that flood (aka the CDN business is optimized for delivery out not protecting in).  Another bad analogy could be the chef's knife is very good for general purpose cutting, but it is a terrible tool for peeling carrots or removing fish scales. A special tool is required for both these tasks.  To sum it up Billy Madison fashion: So, you see, the house was like AKAM's POPs. As the internet evolved the POPs got lost in the woods. And nobody, especially the little farmer - "society" - knew where to find 'em. Except that AKAM is a secularly challenged business. But the internet, my friends, that was a revolution. 

     

    What follows is my short pitch on AKAM.  Similar to Billy Madison there is a chance that what I am about to say is one of the most insanely idiotic things you readers may ever hear, and at no point in my rambling, incoherent response may I be even close to anything that could be considered a rational thought and everyone on VIC will now be dumber for having listened to it.  But given we are already observing this change and all my diligence continues to point towards it I fell confidence.  If not, I will be awarded no points, and may God have mercy on my portfolio.

     

    AKAM is a secular short as their core business is being commoditzed as the evolving internet architecture has eroded their primary moat.  AKAM's main bread and butter is operating a CDN network that helps consumers by caching data across the global network.  AKAM built its network when width mattered - as the internet architecture has changed this (moved from width to depth) this has resulted in commoditization - failing prices and margins. 

     

    You have already seen the cracks in AKAM's media business as media pricing has fallen by 20%+ for the last 7 years.  What has kept the SS AKAM afloat is the strong growth and margins in the performance & security division.  AKAM's performance and security division's gross margins are something like 2.5x what they achieve on media delivery solutions.  Media delivery is shrinking topline by high single digits.  Performance and security has been growing by low double digits.  The problem with this is a growing market with 80%+ gross margins has quickly attracted competition and as AKAM's core business is erroding they have moved into other areas.  AKAM is going after higher margin areas like performance and security and AMZN and others are also targeting those areas which will whittle away the margins.  We will see exactly what happened with media CDN replay in the performance and security (for frame of reference media CDN went from a 60% margin business to something closer to 30% over the span of three years).  Why is this happening now?  Well CDN has become a commodity and as providers (AKAM, Fastly, Verizon, Amazon, etc.) have mastered this area they are slowly moving up the value stack.  Speaking with customers we are already seeing the price point for value added services beginning to drop - you even saw this in the weak guidance and numbers from AKAM in the last quarter.  To make matters worse within the market AKAM is charging 2x-3x what others are charging.  AKAM now competes for about 75% of its web performance business and that number is rapidly growing. A good example of this was the NY Times was a AKAM shop and tried to leverage them for more advanced services and immediately regretted it.  This introduced a lot of complexity and cost and was not valuable.  What ended up happening is the NY Times shifted over to Fastly which was drastically cheaper and introduced a standardized interface that was extremely user friendly.  When old media calls your product clunky and your tech commoditized that is usually not a good sign.

     

    The one supposed saving grace for AKAM is security.  AKAM offers a very basic DDOS and WAF.  They will likely dive further into the security stack to diversify away from rapidly commoditizing assets.  The problem with this is DDOS and WAF are the extreme low hanging fruit in cybersecurity (fairly commoditized themselves) and the further AKAM tries to poke its head in this market the more likely it is to run into a big boy.  Further you can't just cobble together new services on AKAM and hope they will work.  AKAM is not too dis-similar from Blackberry - a decade ago it was cutting edge for large file object delivery but when you ask it to do something else (surf the internet, load balance, or DDOS) then you start to see the scare tissue that has built up.  AKAM is often now bumping heads against IMPV in the market.  IMPV's inability to sell itself shows how attractive that underlying market really is in the eyes of the industry.  Cyber security is too small a segment for AKAM right now to be meaningful and the only chance AKAM has of making a big splash would be a large and dilutive acquisition.  Something I think CEO and Co-FOunder Tom Leighton is incapable of doing. 

     

    The other bull hope is that 4K streaming will become so huge as to override any declines in media pricing.  This is not happening.  Further there are mass usage issues that will prevent this - no one is streaming in 4K because: 1) they can't and 2) most streaming media is consumed on a form factor that makes 4K a waste of time.  The difference between HD and 4K on your cellphone is pretty undetectable and streaming media companies know this so they are not rushing to spend oodles of dollars for zero benefit. 

     

    As AKAM's performance business starts to commoditize you will see topline slow and margins drop.  This will culminate with AKAM's multiple dropping.  You have a company that is growing topline in the mid single digits and in FY18 Adj EPS (since they do a large amount of massaging between GAAP and Adj) is going to grow at low double digits.  People will eventually see AKAM for what it is - a legacy piece of tech and will apply an appropriate multiple.

     

    AKAM is also attractive as a short since it hash little to no risk of getting bought out.  Now large tech company would want them as most can do it in-house (all do in fact except MSFT farms it out since they view CDN as low value-add).  Earnings will continue to disappoint as pricing and margins drop accordingly.  I would not be surprised to see this slowly sink down to the $30s (roughly 15x my 2019 Adj EPS).  There are not many outs AKAM can do - you can try and repurchase as much stock as you like but that won't change dying topline growth and decaying margins.  

     

    Finally - Knibb High Football Rules! (Apologies to those who are reading this and are unfamiliar with the classic piece of cinematic canon that is Billy Madison).

    I do not hold a position with the issuer such as employment, directorship, or consultancy.
    I and/or others I advise do not hold a material investment in the issuer's securities.

    Catalyst

    In the short-run, the Streaming Media summit should have some announcements from Google and AMZN that are not helpful to AKAM.  In the long-run, each quarter competition will continue to drive pricing lower and take larger chunks of market share.  

     

    Messages


    SubjectInteresting Idea
    Entry05/27/2017 12:20 PM
    MemberAkritai

    Thanks for the very interesting idea!!!!

    When do you think this plays out??

    I agree w/ you about AKAM's CDN segment, we've seen a fair amt of their larget customers taken this business in house (i.e. FB), but I could never get comfort around the timing of CDN's decline or any catalyst. 

    Also, agree about Cyber. It's too small to make a difference, though AKAM has been trying everything to boost it (buying small companies, new products, etc...etc...). 

    Knibb High Football Rules! 


    SubjectRe: Interesting Idea
    Entry05/29/2017 05:00 PM
    Memberu0422811

    You are already starting to see this play out. At the recent CDN Summit Dab Rayburn said that performance pricing will be down 30% for standard services in 2017. This is further backed by the money Fastly just raised and is using to arb the performance side. Instart Logic is also growing quickly and does not suffer from the same bad plumbing problem as AKAM.

    So we are seeing this already and I would not be surprised if AKAM whiffs again and the multiple compresses accordingly. Media delivery also continues to be bad.


    SubjectRe: Re: Re: Interesting Idea
    Entry06/07/2017 10:17 PM
    Memberu0422811

    I have not looked at CCOI in detail - but am tempted to now if you think it maps.  Thanks for the tip. 

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