Can Akamai Overcome This?

Welcome to the new world of tech, where even sturdy businesses get killed by the credit crunch. The latest victim: Akamai Technologies (Nasdaq: AKAM  ) . My first -- and thus far best -- pick for Motley Fool Rule Breakers is taking a beating today.

You might say it's deserved. Management reduced 2008 revenue guidance from $800 to $825 million to $785 to $800 million. Normalized per-share earnings are now expected to come in between $1.63 to $1.69, down from earlier estimates of $1.68 to $1.71.

Is Apple next?
Blame iTunes, Gootube, and the rest of the digital media industry. That's what Akamai CEO Paul Sagan did, sort of. During a conference call with analysts and investors, he said that growth in the media and entertainment segment of its business had moderated from stratospheric growth a year ago to high growth today.

The implication? Challengers to Apple's (Nasdaq: AAPL  ) iTunes crown may not be spending as fast, or as loosely, as they used to. I say "challengers" because Akamai realized yet another increase in its average revenue per customer, to $23,700, up 19% over last year's second quarter and well ahead of the $23,200 reported during the first.

Translated, this means that the once and future dot-com darling has captured the hearts of big customers like Microsoft (Nasdaq: MSFT  ) , Sony (NYSE: SNE  ) , and Nintendo (OTC BB: NTDOY.PK), and that they've remained loyal.

Nevertheless, slowing growth is slowing growth, and that represents a shift in the underlying business. Media and entertainment tends to account for between 40% and 45% of Akamai's revenue, Sagan confirmed in my interview with him yesterday. As investors, we're forced to ask: Can this problem be overcome? And, if so, how?

Investing through tough times
Akamai has two huge advantages. First, there's the technology, which is like a helicopter for Web traffic. Its private network of 36,000 servers uses an algorithm -- created at the Massachusetts Institute of Technology in the late '90s -- to deliver data faster than would ordinarily be possible on the Internet's crowded highways. So popular is this service that, according to company estimates, Akamai's servers deliver more than 20% of the Web's traffic.

Better still: Akamai has approached its business differently than peers. Whereas Limelight and upstarts such as BitGravity have touted their experience with delivering video, Akamai has been doing that and enabling e-commerce business models -- Best Buy (NYSE: BBY  ) and Overstock (Nasdaq: OSTK  ) are customers Sagan mentioned -- as well as the delivery of corporate data over the Web.

Second, Akamai is a financial thoroughbred. Second-quarter normalized earnings per share improved by 38%, revenue improved by 27%, and free cash flow through the first six months of the year more than tripled to just under $100 million. Capital spending, meanwhile, declined just 4% over the same period.

Then there's the balance sheet. Akamai has $287 million in cash and short-term investments and $453 million in long-term securities holdings, $280 million of which are auction-rate securities that aren't likely to be sold soon. Still, that's a ton of buying power that Limelight and especially Level 3 (Nasdaq: LVLT  ) , encumbered with more than $6 billion in net debt, don't possess.

And be assured, Sagan and his team have every interest in investing that capital. Here's how he put it during the conference call:

Outside of media we've seen strong growth particularly for some of our newest offerings such as Application Acceleration, and our Dynamic Site Solutions. Innovating in these categories and continually adding enhancements to these newer solutions isn't by chance, it is a deliberate strategy to diversify and extend our portfolio and invest our R&D dollars where we believe we will see the best returns, and we think that's exactly what's happened.

Akamai has added nearly 9,000 servers since last summer, expanding its network by more than 30%. Management has produced an 8.8% return on invested capital over the same period, up 50 basis points from March and continuing a string of ROIC gains that dates back to 2005.

Which brings us back to the question posed in the title: Can Akamai overcome slower growth in its largest segment? Certainly, and especially if management continues to invest successfully in new services. I believe that they will.

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Fool contributor Tim Beyers owned shares of Akamai at the time of publication. Tim also contributes to Rule Breakers, which counts Akamai among its core holdings. The Motley Fool owns shares of Best Buy. Its disclosure policy is typed out. Going to bed now.

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Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On July 31, 2008, at 5:12 PM, foolfanuno wrote:

    Hello, Akamai's network was built for optimization of image delivery. To do what companies like BitGravity are already doing requires them to expend a great deal of revenue on infrastructure above what is needed. Watch CTO of Bitgravity Barrett Lyon speak on Revision3's show "The Revision3 Gazette" He was at the Demo Awards and spoke directly about why companies like Akamai(without using the name) may be large, but not necessarily optimal from either a cost or service standpoint for video content or other bandwidth intensive cloud computing services. I can see why non-tech folks may think that Akamai is a good investment, but I think the long term reality is different...

  • Report this Comment On July 31, 2008, at 5:17 PM, TMFMileHigh wrote:

    Hello foolfanuno. Thanks for commenting. Yes, BitGravity looks interesting. It may even be a Rule Breaker in the making. But the numbers don't support that idea that Akamai is the CDN equivalent of drudgery. Were that true, ARPU would be declining rather than improving.

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