About 10 years ago, the mastermind of the World Wide Web, Tim Berners-Lee, issued a challenge to his brilliant colleagues at MIT: If the Internet is going to grow, and allow for such things as video, the infrastructure needs to improve. MIT math professor Tom Leighton and graduate student Danny Lewin answered the call. The result is a hypergrowth company, Akamai (Nasdaq: AKAM ) , and over the past few years, it's become a great stock for investors.
Akamai's technology has allowed the Internet to broadcast live events such as the Winter Olympics, college basketball's March Madness, the Super Bowl, the World Baseball Classic, and the World Cup. The software delivers a seamless experience for viewers, even when Web traffic spikes unexpectedly.
Broadband growth is the biggest driver for Akamai's business. A study from IDC projects 18.4% annual growth in the U.S. broadband market from 2004 to 2009. (The worldwide growth rate is 16.6%.) By 2009, IDC expects 273.4 million broadband-equipped households.
Akamai's technology has several advantages. First, it's reliable. Just imagine if E*Trade's online brokerage system slowed down or stopped altogether. Besides an immediate loss of revenue, the company may also face long-term problems if customers start to think about alternatives and open an account with a rival brokerage instead.
Finally, Akamai's technology is highly secure. In fact, its systems take a proactive approach, trying to prevent nasty things like viruses, worms, and attacks.
At the core of Akamai's technology is a worldwide network of nearly 20,000 servers, covering 71 countries. Locating servers near online users creates less traffic congestion and capacity problems; Akamai calls this the "edge" of the Internet.
Akamai continues to invest aggressively in this network. In the first quarter, the company spent $16.2 million in these capital expenditures. By making these large purchases, the company also realizes volume discounts.
No doubt, this network is an enormous competitive advantage. It would take years -- as well as millions of dollars -- to replicate.
Akamai's growth has certainly been stunning. In the first quarter, revenues surged 51% to $90.8 million and increased 10% over the prior quarter. Net income was $11.5 million, or $0.07 per share. This includes expensing for stock options, which was $7.1 million, or $0.04 per share.
Akamai's business model allows for significant cash flow. In the first quarter, cash flow from operations was $33.2 million, up from $18.7 million in the year-ago period. In all, the company had $284 million in the bank at the end of the first quarter.
This cash hoard gives Akamai the firepower to buy other companies; last year, the company purchased Speedera, a fast-growing competitor. But according to the latest earnings conference call by Paul Sagan, Akamai's CEO: "There are not a lot of deals that look as good as Speedera. ... That was a very successful acquisition for us."
Akamai's strong sales pipeline is equally important. The first quarter included 71 new-customer acquisitions, a 46% increase year over year, for a total of 1,981 customers.
Better yet, customers' contracts are lengthening in duration. The average is now about 18 months, which is up from 15 to 16 months last year. Customers see the value of Akamai's services and want to make sure it has enough capacity for their increased needs.
But aren't Akamai's customers concentrated in digital media? Yes, that's the biggest category, but Akamai has expanded its customer base into such areas as e-commerce, financial services, travel, software and technology, and even the public sector. According to Sagan, during the company's earnings conference call: "Now, before we let digital media grab all of the headlines, we should note that overall, we are seeing very strong demand in our core content-delivery service business as more and more enterprises continue to move critical processes online."
In its first-quarter conference call, Akamai's management increased its revenue and earnings guidance. Revenues are expected to be $380 million for the full year, with normalized earnings of $0.73 per share, excluding the impact of option expensing.
This translates into a forward P/E of 42 as of yesterday's close. True, this is not cheap, but a fast-growing company like Akamai rarely is. If anything, such companies often trade at a premium.
Akamai is not a stock for a conservative portfolio, but as long as it continues to push growth aggressively, this winning Rule Breakers newsletter recommendation will likely be a top performer.
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Fool contributor Tom Taulli does not own shares mentioned in this article.