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

With major changes underway in the content delivery network space, what does the future hold for Level 3 Communications and Akamai Technologies?

Jul 9, 2014 at 9:00PM

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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Brian Nichols owns shares of Apple and Verizon Communications. The Motley Fool recommends Apple. The Motley Fool owns shares of Apple. Try any of our Foolish newsletter services free for 30 days. 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 has a disclosure policy.

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