Akamai Shuts Off the Limelight

Go figure. Shares of Motley Fool Rule Breakers recommendation Akamai Technologies (Nasdaq: AKAM  ) , which last week won a jury verdict in its patent tussle with Limelight Networks (Nasdaq: LLNW  ) , are off more than 6% since Friday.

Dumb. Even though Akamai stands to gain little more than $45 million in cash -- easily affordable for its flush competitor -- Mr. Market is ignoring the implications of this victory, which could be worth billions. Here's how.

Anatomy of a competitive advantage
The knock on Akamai is that low-priced competitors can eat away at its market share and margins. Limelight was the poster child for this argument, which, if the numbers are to be believed, has some merit. Behold:

Gross Margin

2007

2006

2005

2004

Akamai

73.7%

78.0%

80.3%

78.0%

Limelight

36.4%

60.1%

57.6%

56.8%

Source: Capital IQ, a division of Standard & Poor's.

Yet Limelight isn't the only one to attack Akamai on price. Privately held EdgeCast takes a similar approach, according to EdgeCast President James Segil, whom I interviewed last month.

Segil says Akamai's decentralized network of more than 30,000 servers breeds inefficiency. "Akamai's customers are paying more for less," he asserts, pointing to Limelight as an example.

He may be right. Limelight has seen a massive increase in traffic from big customers such as Microsoft (Nasdaq: MSFT  ) , Amazon.com (Nasdaq: AMZN  ) , and Facebook without adding substantially to its network, which Segil says is composed of 16 "POPs," or "points of presence," by which data is delivered over the Web. EdgeCast has 13. Akamai has thousands. Fewer points of presence should equal lower fixed costs.

Thus the theory: Akamai may be vulnerable to up-and-coming price cutters, especially those such as EdgeCast, which appears to share the design advantages that make Limelight appealing.

Except that last week's court loss may have eliminated this theoretical advantage. It suggests that network design differences don't matter. Akamai's patent -- number 6,108,703 filed with the U.S. Patent and Trademark Office -- covers content delivery comprehensively. Quoting from the patent's text:

The present invention is a network architecture or framework that supports hosting and content distribution on a truly global scale. The inventive framework allows a Content Provider to replicate and serve its most popular content at an unlimited number of points throughout the world. The inventive framework comprises a set of servers operating in a distributed manner. The actual content to be served is preferably supported on a set of hosting servers (sometimes referred to as ghost servers). This content comprises HTML page objects that, conventionally, are served from a Content Provider site. In accordance with the invention, however, a base HTML document portion of a Web page is served from the Content Provider's site while one or more embedded objects for the page are served from the hosting servers, preferably, those hosting servers near the client machine. By serving the base HTML document from the Content Provider's site, the Content Provider maintains control over the content. [Emphasis added.]

Notice the language. I'm no legal scholar, but I'll bet attorneys at Limelight were arguing that because its network isn't the distributed beast that Akamai employs, it doesn't infringe the patent. Jurors apparently didn't agree.

$45 million is just the beginning
This case isn't over. Plenty more Akamai rivals already exist, and others could enter its market tomorrow -- Level 3 (Nasdaq: LVLT  ) , InterNAP (Nasdaq: INAP  ) , and Google (Nasdaq: GOOG  ) , for example.

But Akamai is the first mover. It has the dominant market share. And now, with legal validation, it preserves the technology advantage that it has long claimed, one which breeds excellent margins and cash flow. That, and not a $45 million settlement, is why David Gardner calls Akamai one of his core Rule Breakers.

For more on Akamai:


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