The Big Problem With Akamai's Quarter (and Why It Doesn't Matter)

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With the stock down more than 15% today and 26% year to date, it's clear that investors are souring over Akamai Technologies (Nasdaq: AKAM  ) .

Can you blame them? Revenue grew 15% while normalized per-share earnings improved just 9% in the first quarter, and that's with Akamai's higher-margin value-added services now accounting for 58% of revenue. But that's not the worst part. Management expects essentially zero sequential revenue or earnings gains in Q2.

At the midpoint of guidance, second-quarter revenue would be up just 12% year over year. Growth is slowing, fast. That could be the result of increasing competition from upstarts such as Cotendo and EdgeCast.

Both companies have partnerships with AT&T (NYSE: T  ) , and Cotendo has been working with Google (Nasdaq: GOOG  ) on an open-source form of application acceleration. (Akamai says the approach violates its patents.)

And these are the small potatoes. Direct peer Limelight Networks (Nasdaq: LLNW  ) booked $183 million in revenue last year, up 39% over the year prior. Level 3 Communications (Nasdaq: LVLT  ) has invested tens of millions to build out its own content delivery services to handle the bulk of Netflix's video streaming business.

So there's reason to worry a little. But the outlook isn't the most important part of Akamai's Q1 report. We've known since Q4 that growth wouldn't accelerate again until the second half of this year, when the recent spate of contract resignings should begin to pay off.

All this pales compared to a single number: 32%. Cost of revenues rose that fast during Q1, more than twice the rate of revenue growth.

Servers account for a good portion of the spending. Akamai has added nearly 24,000 new boxes over the past year. CEO Paul Sagan said in an interview yesterday that his company's goal is to "increase reach" globally by adding servers to new networks connected to the traditional and Mobile Web.

That makes sense. As an industry, Akamai and its peers are in the early stages of creating a cloud-computing infrastructure that will carry 26 times more mobile data in 2015 than it did last year, according to a Cisco Systems research report. Akamai is sacrificing some portion of profits now to capture a greater share of this traffic growth later.

Today's sellers don't believe that strategy will pay off. I think they're wrong. What do you say? Tell us what you think about Akamai's report, approach, and competitive differentiation using the comments box below. You can also rate Akamai in Motley Fool CAPS.

The Motley Fool recently introduced a free My Watchlist feature that allows users to stay ahead of the curve and receive up to date news on companies like Akamai, or any of its peers or competitors. To get up-to-date news and analysis, add these companies to your watchlist today:

AT&T and Google are Motley Fool Inside Value picks. Akamai and Google are Motley Fool Rule Breakers recommendations. Netflix is a Motley Fool Stock Advisor selection. Alpha Newsletter Account LLC owns shares of Cisco and has purchased Netflix puts. Try any of our Foolish newsletter services free for 30 days.

Fool contributor Tim Beyers is a member of the Rule Breakers stock-picking team. He owned shares of Akamai and Google at the time of publication. Check out Tim's portfolio holdings and Foolish writings, or connect with him on Twitter as @milehighfool. You can also get his insights delivered directly to your RSS reader. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool owns shares of Google and has created a bull call spread position in Cisco. The Fool is also on Twitter as @TheMotleyFool. Its disclosure policy is too fast to be seen by normal means.

Read/Post Comments (3) | Recommend This Article (9)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On April 28, 2011, at 7:42 PM, traderpat9 wrote:

    akam is headed in the right direction. you have to use some profits to update & add equipment & if they are already planning for 2015 they are ahead of 99.9% of all companies-some of which have no idea what next year will bring & have no game plan-akam will be a kiler stock!!

  • Report this Comment On April 29, 2011, at 10:27 AM, noahbeltran wrote:

    Any company who is investing a significant amount of money into expansion should be dong so with an expected profit margin/ROI. Akamai's CEO did not have one. So,rather than using ROI to make decisions he's instead crossing his fingers with stock holders money? He's getting millions win or loose. His comments, to me on the call said he could care less about the stockholders and , even though he is a publicly traded company, he has no obligation to investors to keep them informed on why he is spending for expansion. FYI, I got killed with this trash stock buying in at 43.

  • Report this Comment On May 04, 2011, at 10:27 AM, wordguru wrote:

    As we know, AKAM stock has a seasonal element with the high point being in Q4. The company is used to this and is using it to its advantage... keep expectations low in the first half, invest in infrastructure, buy back stock and then make a run. Akamai has been switching moving into higher margin value-added services for some time and they have been very vocal about it. What's more, they have succeeded. It is now the fastest growing revenue and will be the biggest revenue contributor by the end of the year. What they are not sharing is what is their next product platforms (to the above person's statement--the CEO doesn't share much in the way of expansion/strategy), but with all these other companies chasing your tail, I think it is best they play it closer to vest. Look for not AKAM to get acquired this year, but to make a couple key acquisitions to push its lead in mobile delivery technology. EOY makes +15% growth and closes above $45. The company will buy low and so will I.

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