Akamai Correction Overdone Post Apple's CDN Debut

  • Akamai’s stock is down by over 14% in less than a month.
  • Akamai’s valuations indicate an overreaction to Apple’s CDN launch.
  • Akamai has a huge upside potential at its current stock price.

Akamai’s (NASDAQ:AKAM) stock has lost a little over 14% in a little less than a month. Part of the fall could be attributed to the weak global economic outlook, which has dragged markets in general and triggered broad based corrections. However, news that Apple (NASDAQ:AAPL) used its own CDN (content delivery network) to deliver its iOS 8 update surfaced on 18 Sep 2014. The steep correction in Akamai’s stock price coincides with the news. Our valuation of Akamai based on conservative projections of revenue, factoring in the assumption of loss of revenue from Apple, lead us to believe that the correction might be overdone. We see a potential upside in Akamai’s valuations given its solid financials.

Apple's CDN Hurts Akamai’s Stock Price

Apple has been known to be working on developing its own CDN for a while now. However, the company’s iOS 8 launch on 17th September is reportedly the first time that Apple deployed its data distribution infrastructure on a large scale. Akamai’s stock saw a sharp correction thereafter, falling by close to 6% in 3 sessions.

The expectation is that Apple will gradually start to fulfil some of its data delivery requirements with its own CDN. Data delivery, which forms a part of user experience, is currently handled by third party CDNs like Akamai.

Over time, Apple will want to gain more control over that aspect of user experience and is believed to have put in place huge capacity for data delivery. However, it’s unlikely that Apple will handle all of its requirements internally, at least in the immediate future.

One must also note that though Apple handled a big chunk of the traffic, Akamai was still part of the mix.

Apple CDN Impact On Akamai Revenue

Akamai reportedly earns about 10% of its revenue from Apple. It’s not likely that it will lose all of its business from Apple. However, to be conservative, we projected Akamai’s revenue over the next two quarters, Q3 and Q4 2014, excluding the 10% contribution from Apple.

Growth has been accelerating in Akamai’s top two revenue segments, Media Delivery Solutions and Performance & Security Solutions. However, here again, we’ve used the average growth rates over the past 4 quarters for the projections.

Assuming Akamai’s revenue from Apple goes missing from Q3 2014, YoY growth rates would slow to about 10% each in Q3 and Q4 2014 and Akamai would end up with a full year revenue growth of about 17%. That’s still higher than the company’s FY 2013 growth of 15%.

Akamai Revenue Growth and Profitability

We’ve made our projections assuming the worst possible outcome from Apple’s CDN service launch. However, it’s very unlikely that things will pan out that way. Further, Akamai is gaining business from other sources, like the deal it struck with China telecom. Here’s an excerpt from the press release on Akamai’s site:

“As part of the strategic partnership, CT Cloud has agreed to offer an integrated solution incorporating Akamai's full suite of industry-leading media delivery, Web performance, and cloud security offerings with its own Cloud services to Chinese businesses looking to grow their global Web presence.”

Growth in Akamai’s Media Delivery Solutions segment has been accelerating consistently over the last year, peaking at 20.5% YoY in Q2 2014. During Q2, the FIFA World Cup drove traffic on Akamai’s servers, setting records for peak traffic. Since the second half of the event including the finals took place in July, Akamai could see even higher levels of traffic in Q3.

The company’s Performance & Security Solutions business has also been accelerating consistently over the last year. The segment became the company’s biggest source of revenue in Q2 2014. With accelerating growth in both of Akamai’s major revenue streams, its overall revenue growth has been robust.

Akamai Revenue growth

Akamai’s profit margins declined marginally in Q2 2014 compared to the average profit margins over the last year. However, the company did manage to deliver an EPS (earnings per share) expansion of 18% YoY to clock an EPS of $0.40 a share. Akamai also generated a healthy operating cash flow of $200 million, or 42% of revenue, during the same quarter.

Akamai’s financials are robust with accelerating revenue growth and predictable, healthy profit margins.

Akamai Valuations

Akamai is still down by about 13.5% since its close on 18 Sep 2014. Even if one were to go by the conservative projections we discussed earlier, Akamai is trading at a Price to Sales ratio of 5.38, based on FY 2014 revenue.

Akamai has been trading at an average Price to Sales (PS) ratio of a little over 6 over the last twelve months (LTM). Valued at its LTM PS ratio, Akamai has an upside potential of about 11.5% from its current stock price of $55.65 a share, with a target price of $62 a share.

However, applying that to consensus analyst estimates would drive Akamai’s valuations much higher. Consensus estimates expect Akamai to end the year with a revenue of $2 billion. At a PS multiple of 6, Akamai’s valuations have a potential upside of 21%, implying that the stock should be trading at $67 a share by the end of the year, or early next year (when results are announced).

Given the company’s strong financials and its current valuations, our Akamai stock analysis assigns the stock a buy rating. Akamai is one of our top stock picks. Our Akamai stock analysis video covers more fundamental aspects of the company’s business.

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Neither Amigobulls, nor any members of its staff hold positions in any of the stocks discussed in this post. The author may not be a certified/registered investment advisor, and the opinions expressed should not be treated as investment advice. Buying and selling of securities carries the risk of monetary losses. Readers/Viewers are advised to carry out their own due diligence and consult their investment advisors before making any investment decisions. Neither Amigobulls, nor the author have any business relationship with any of the companies covered in this post.

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