Can Level 3 & Akamai Survive Big Changes in the Network Delivery Market?

Akamai Technologies  (NASDAQ: AKAM  ) and Level 3 Communications (NYSE: LVLT  ) are both large providers of CDN services. These content delivery networks are widely used in technology and telecom, but as large companies like Apple (NASDAQ: AAPL  ) and, now, Verizon Communications (NYSE: VZ  ) elect to build or acquire their own CDN networks, what does this mean for Akamai and Level 3?

The build-outs begin
Back in early 2014, Apple began the process of building its own CDN. In the past, Apple had used both Level 3 and Akamai for CDN services to deliver applications, services, and content to its users. However, as Apple's network has surpassed 700 million users and continues to grow, creating a proprietary CDN made sense as a way to protect margins long-term.

The other benefit of building, rather than renting, a network is full control. These CDNs are instrumental in how users experience Apple's ecosystem, and it makes sense for the company to seek full control of this power.

What happens to Akamai and Level 3?
The end result will be lost business for both Akamai and Level 3. The former is believed to be Apple's largest CDN client, with more than $100 million paid for services. Akamai has grown revenue at a 15.5% annualized rate over the last three years, as it still finds plenty of business with smaller up-and-coming technology companies in need of CDN services.

However, a $100 million loss would be equivalent to 15% of Akamai's 2013 revenue. In other words, losing too many of these large customers could essentially wipe out Akamai's growth.

As for Level 3, its $6.3 billion in 12-month revenue, and its diversified services, gives it a little more protection against this movement. Certainly, the company has high exposure to this enterprise space, but with more miles of fiber than any other company in the world, it is also a key provider of content delivery on many consumer services like Internet.

The acquisition approach
With that said, Akamai looks to be the real loser in the build-your-own-CDN movement within the enterprise space. Just last week, Verizon presented a new CDN service to improve content delivery in the e-commerce industry.

While Apple builds its own CDN platform, Verizon took the road of acquiring one of Akamai's top competitors, EdgeCast, for $350 million. Therefore, Akamai is not only losing a customer, but also gaining a competitor with this move.

Albeit, CDN services are unlikely to ever become a large piece of Verizon's fundamental pie. However, with telecom companies placing so much emphasis on broadband and increasing content speeds, it's no surprise the company wants full control of the delivery network.

Is Level 3 or Akamai still a good investment?
The bottom line is that it's hard to find a way Akamai comes out on top in this new CDN market long-term. The company may continue to perform short-term, but if it loses too many of its top clients, many of which could then become competitors, the company won't have a hedge for protection.

Level 3 is a much larger global company, and its fiber network is its hedge as these changes occur. Moreover, this fiber network, which includes 35,000 miles for Level 3 and 27,000 route miles for newly acquired TW Telecom (with much being in metropolitan areas), makes it nearly impossible for customers to build a better network.

Foolish thoughts
As a result, there is still a place in this market for Level 3, but Akamai might want to explore strategic options. Albeit, Akamai, at 22.2 times next year's earnings, is very much valued like a company with 15% annualized growth, but the reality is that this growth could be undercut very quickly.

On the other hand, Level 3 is focused on efficiency rather than growth, and with operating margins being half that of Akamai's, there could still be significant room to improve, thus creating shareholder value.

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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 July 10, 2014, at 5:45 PM, DanRayburn wrote:

    There are a bunch of statements in this post that are not accurate.

    Apple didn't start building out their CDN in "early 2014", they started the buildout in 2013.

    It says that "In the past, Apple had used both Level 3 and Akamai for CDN services", it's not "in the past", Apple is still using both Akamai and Level 3. It's present.

    Apple does not have a "network" that "has surpassed 700 million users". Platform yes, but not a "network".

    "The end result will be lost business for both Akamai and Level 3." Not true. Apple is buying a ton of wavelengths and other network services from Level 3 already, so any CDN business Level 3 loses, will be made up for with other services.

    Yes, Akamai will lose revenue from this, but it won't be overnight or quickly. Apple won't simply shut off Akamai all at once, is a slow and gradual process, usually over a 12-24 month period. AND Apple will still use Akamai in some capacity. So implying Akamai will lose 15% of their revenue, in one year from Apple, is not accurate.

    However, a $100 million loss would be equivalent to 15% of Akamai's 2013 revenue. In other words, losing too many of these large customers could essentially wipe out Akamai's growth.

    Level 3 is a "key provider of content delivery on many consumer services like Internet." That doesn't make any sense.

    "build-your-own-CDN movement within the enterprise space". Enterprises aren't building their own CDNs and CDN services are not classified as "enterprise". Apple and Netflix are media and entertainment. And there is no "movement" in the market, there are only a handful of companies who have built their own CDNs.

    EdgeCast was acquired for nearly $400M, not $350M.

    There is no "new CDN market". Microsoft, Google, Netflix, Apple, Twitch, Yahoo, have built or are building their own CDNs, but it's not new. One customer their size, per year, building their own CDN is not a "new market".

    "many of which could then become competitors"

    Apple is not a competitor to Akamai when they build ther own CDN. Neither is Netflix, Microsoft, or Yahoo. They aren't building a CDN to sell it to others, aside from Verizon.

    After all these points, you then say "Akamai might want to explore strategic options." But you don't suggest or highlight what those "options" should be.

  • Report this Comment On July 16, 2014, at 12:54 PM, damilkman wrote:

    I would not bag on the author to bad. His point is that CDN like Internet Wholesale is losing it's margins as some of the biggest players build enough critical mass to dictate terms. Ten years ago Comcast was paying ISP's for transit. Now there are battles whether ISP's should compensate Comcast.

    Dan Rayburn is correct that this has been going on since AOL became its own peer. But Apple moving away still makes it worthwhile to question whether a pure CDN play is viable. This is the same question that Internet resellers had to ask whether it was viable to be in the business without owning fiber.

  • Report this Comment On July 22, 2014, at 11:18 AM, MayTepper wrote:

    William Blair Maintains Outperform On Akamai Tech Ahead Of 2Q14 Report http://bit.ly/Um4aTX

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