Verizon (NYSE: VZ) announced its acquisition of EdgeCast Networks on Monday. EdgeCast is a content delivery network, or CDN, provider that sells its services to companies like Twitter, Pinterest, and Hulu, and it competes with companies like Akamai (NASDAQ: AKAM) and Level 3 (NYSE: LVLT). Verizon's acquisition of the network could have a significant impact on the CDN provider market.
What will Verizon do with EdgeCast?
In short, nothing. EdgeCast will simply replace Verizon's home-baked CDN and become part of Verizon's Digital Media Services, or VDMS, group. EdgeCast ought to continue operating as usual.
What Verizon will likely do with EdgeCast is provide a strong financial backing for a profitable business. One of the biggest challenges for CDNs is increasing R&D expenditure as its often limited by revenue growth. And although revenue growth at Akamai, Level 3, and other CDNs has been strong in the past, analysts expect that growth to slow in the future. That trend is already visible in longtime CDN expert Limelight Networks.
Verizon ought to give a strong boost to EdgeCast's efforts to scale its network, which should support revenue growth for the company. In other words, competing CDNs could see Verizon capture market share with EdgeCast by outspending them.
The whole package
The EdgeCast acquisition comes just a few weeks after Verizon bought digital media streaming company UpLynk. The two acquisitions coupled with Verizon's position in video services with FiOS TV give Verizon a complete video ecosystem.
Verizon has content partnerships through its FiOS segment, transcoding technology necessary for playback on any device, content delivery through EdgeCast, and with UpLynk a front-end management software solution. Verizon could market this package to broadcasters as an alternative to Level 3's ecosystem, which has had great success marketing its all-in-one solution.
Verizon could potentially undercut Level 3's pricing. Verizon has multiple revenue streams to support lower margins at EdgeCast, but moreover should be able to reduce EdgeCast's costs. This will allow Verizon, if it's so inclined, to reduce the price of its CDN services in order to gain market share.
Bad news for Akamai
Aside from potential pricing pressure, this is especially bad news for Akamai. Verizon is a big reseller of Akamai's services, and with this EdgeCast acquisition it's likely that partnership will come to an end.
Additionally, Akamai has been trying to improve its position with wireless carriers. EdgeCast already has a huge lead in the market, as it's been the company's main focus since its inception. With the acquisition by Verizon, it should only strengthen its position as the go to CDN service for telecom companies.
This could also impact Akamai's business with media companies should Verizon begin providing a package like Level 3. Akamai doesn't have the same framework to build a complete ecosystem like Verizon, and it doesn't have the cash to put the pieces together quickly. Granted, Akamai has held its own in the video delivery market, but a lot of growth has come from the expansion of the video streaming market as a whole.
Last year, Netflix decided to take its CDN in-house, negatively impacting one of the company's bigger revenue sources. Next year, Akamai may see a decline in revenue from another big customer. On the company's third quarter conference call, CFO James Benson mentioned renogotiation with the company's largest media customer, thought to be Apple, will have a negative impact on revenue as early as the fourth quarter.
Akamai may be hard-pressed to continue growing its video delivery business with Verizon now in the fold and Netflix becoming more self-reliant. Aside from a more complete service, Verizon could offer better pricing in a market that already has tremendous downward pressure on pricing.
Big names moving in
Verizon is just one of several large companies that are getting serious about CDN services. Netflix, as mentioned, is another one, and Amazon continues to improve its CloudFront service.
Still, Akamai is the leader in the industry, and has a lot of strong competencies that these companies can't or don't match ... yet. Level 3, likewise, has a very strong video delivery platform, and could still benefit from the continued growth of video streaming. In the long run, however, I see Verizon and other larger companies materially impacting the industry as a whole.
Editor's Note: A previous version of this article mentioned that Netflix was thought to be Akamai's largest media customer. This has been corrected.
Great picks for the long-term investor
As every savvy investor knows, Warren Buffett didn't make billions by betting on half-baked stocks. He isolated his best few ideas, bet big, and rode them to riches, hardly ever selling. You deserve the same. That's why our CEO, legendary investor Tom Gardner, has permitted us to reveal The Motley Fool's 3 Stocks to Own Forever. These picks are free today! Just click here now to uncover the three companies we love.