Akamai: The Year of Living Profitably

The rumors are true. Motley Fool Rule Breakers recommendation Akamai Technologies (Nasdaq: AKAM  ) is the muscle behind Apple's (Nasdaq: AAPL  ) new movie-rental service.

Impressive as that may be, it's just one of dozens of deals for the Web-content delivery king. On Wednesday evening, Akamai attributed impressive fourth-quarter and full-year financial results to a growing roster of big spenders. Quoting chief financial officer J.D. Sherman:

Our consolidated ARPU, or average revenue per customer, grew 12% sequentially to $23,000 in the fourth quarter. That's up 22% year over year. Our average customer now spends more than $275,000 per year with Akamai and we have over 100 customers who spend more than $1 million per year with us. [Emphasis added.]

How, exactly, did that momentum translate to the income statement? For the fourth quarter, revenue improved by 46%. Per-share earnings, reported on a non-GAAP basis -- which excludes non-cash charges such as amortization of intangibles and stock-based compensation -- improved by 52%.

And yet, there was some not-so-great news. Pricing pressure from peers Limelight Networks (Nasdaq: LLNW  ) , InterNAP (Nasdaq: INAP  ) , and Level 3 (Nasdaq: LVLT  ) is taking a toll on gross margin, which declined 460 basis points from Q4 2006 to Q4 2007.

That would be a pretty bad sign, if not for the operating leverage in Akamai's business model. It allows for cost controls, and thus a fatter bottom line. Non-GAAP net margin improved to 41.6% from 37.8% in last year's fourth quarter.

Once more with the gratuitous Jerry Maguire reference
Most encouraging, though, are the cash flow numbers. Those who have followed my coverage of Akamai since 2003 know I've long believed the firm would accelerate its cash production. Thank you, crystal ball:

Metrics

2007

2006

2005

2004

Revenue

$636.4

$428.7

$283.1

$210.0

Free cash flow

$134.9

$62.6

$55.9

$38.9

FCF margin

21.2%

14.6%

19.7%

18.5%

Source: Akamai earnings reports and Capital IQ, a division of Standard & Poor's. Numbers in millions.

Show me the money.

Notice, too, how FCF margin has expanded. That's not insignificant. Only a few months ago, Akamai was left for dead ,when capital expenditures rose 138% as management rolled out a plan to expand network capacity. The company deployed more than 8,000 new servers as a result.

Now we know why. Plenty of Web content remains to be delivered. Video streaming, in particular, has become an explosive business, thanks to social networking and the Apple-Netflix (Nasdaq: NFLX  ) -Amazon.com (Nasdaq: AMZN  ) movie mixer. Akamai is reaping the benefits.

Here's how CEO Paul Sagan put it during yesterday's conference call with investors and analysts:

I think one of the things you saw in the fourth quarter was the strength in e-commerce that we expected but continuing or unexpected strength in media and entertainment, which as you know is our biggest vertical. As more and more entertainment content and games are going online, it drove really tremendous results for us. [Emphasis added.]

Executives expect even better results in the days ahead. Sherman raised 2008 revenue growth guidance from 25%-30% to 26%-30%. Full-year normalized earnings are expected to come in between $1.65 and $1.70 per share.

Think about that for a minute. Akamai, one of the market's fastest-growing businesses, traded for just 18 times management's worst estimate for 2008 net income as of yesterday's close. Talk about impressive.

And yet, listening to the conference call, I get the sense we're witnessing the beginning of a prolonged hypergrowth phase for this rebel. Quoting Sagan once more, this time from an interview with Reuters:

For all the hype and hoopla over the Internet, it is not fully mature. At some point it will be, but we are not fully there. I think we are a decade from that. [Emphasis added.]

That, Fool, is why I still own shares of Akamai. Well done, sirs.

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