After two years of constantly climbing the charts, shares of Web content delivery specialist and Rule Breakers pick Akamai Technologies (Nasdaq: AKAM ) have slowed in the past six months.
That's normal. Still, the halt has some investors worried. They wonder if increased competition from the likes of Internap (Nasdaq: INAP ) , which recently said it expected 30% revenue growth this year, and Level 3 (Nasdaq: LVLT ) , which recently acquired Akamai competitor SAVVIS, would continue to hurt returns.
At least, that was the principal topic at hand when Chief Financial Officer J.D. Sherman spoke to analysts and investors at the Thomas Weisel Partners Internet and Digital Media Conference last Tuesday.
A broadband broadside
Sherman went right to work dispelling concerns by pointing out that broadband adoption, while improving, is still in its infancy globally. Statistics say he's right. Only 45% of American households, or 50 million, have broadband access now, according to Park Associates. Insight Research forecasts that number to grow to 88 million by 2011.
But to hear Sherman is to wonder if that projection is conservative. "I still believe that not only is broadband adoption going to continue to grow and the number of Internet users going to continue to grow, but the average connectivity of the end user is going to continue to increase," he told the audience.
If so, the thinking goes, fatter Web pipes will fuel further demand for streamed content and downloads from consumers who already can't seem to get enough of Apple's (Nasdaq: AAPL ) iTunes and related services from Yahoo! (Nasdaq: YHOO ) and RealNetworks (Nasdaq: RNWK ) . That, too, should benefit Akamai.
Software servicing Akamai
But it also may not be the biggest opportunity. Sherman told his audience that the increasing use of the Web as a business tool -- what's become known as software as a service, or SaaS -- has made its services for speeding the delivery of business data over the Web particularly attractive, citing hardware spending as evidence of the commitment to do more work online.
"You can see it in the way customers are spending their money on applications ... Gartner talks about a $1 billion-plus business today in appliances addressed at accelerating [Web-based business] applications, growing to $3 billion over the next few years. So, there's a pain point there," Sherman said.
He could have also referred to the success of growing firms that enable web-based business software, such as customer records specialist Salesforce.com (NYSE: CRM ) or Web conferencing specialist WebEx (Nasdaq: WEBX ) . Regardless, Akamai today has 125 application acceleration customers.
Fighting the good fight
It's unique services like application acceleration that have long allowed Akamai to charge a premium and keep margins high. But lately, gross margin has been eroding in the face of pricing pressure from rivals. That's a concern for analysts and investors like me.
How does Sherman respond? He says that Akamai's vast network allows for operating leverage, so that even if it's become costlier to acquire new customers, it's extremely easy to earn more from existing clients.
The numbers also support this argument. Akamai's average revenue per user, or ARPU, increased 29% year-over-year in the fourth quarter alone. That could fall some as the customers of application acceleration specialist Netli, which was acquired last month, are moved to Akamai's network. (Netli's average ARPU before the deal was $10,000.)
But Sherman sees Akamai's ARPU growing or at least stabilizing long-term. "So really, what's driving our ARPU this year is just fundamentally growth in our existing customer base as they respond to what's going on in the Web, and as we respond to their needs by upselling them on features and functionality."
Still, upselling may not immediately lead to higher margins. The bigger goal, Sherman says, is to win -- and keep -- as many customers as possible.
"We're seeing larger, longer-term deals, and we're getting more aggressive on pricing to win those deals," Sherman said. "Customers come to us and say, 'I would really like to increase my business with you by four or five times, but I can't do it at these prices. I have to make this work economically for us.' And we say, 'Yes. We'd love to work with you on that.'"
Good idea, J.D. And I'm sure I speak for all shareholders when I say that we hope you continue with that.
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Fool contributor Tim Beyers, who is ranked 1,033 out of more than 24,000 in our Motley Fool CAPS investor-intelligence database, owns shares of Akamai. All of his portfolio holdings can be found at Tim's Fool profile. His thoughts on growth stocks, Foolishness, and investing in general may be found in his blog. Yahoo! is a Stock Advisor pick. The Motley Fool's disclosure policy is a rebel on Wall Street.