Akamai's More Powerful Than You Think

Funny how a year changes things, eh?

Back when The Great Recession's big bear was first baring his teeth, investors feared that Akamai Technologies (Nasdaq: AKAM  ) , a long-standing member of our Motley Fool Rule Breakers scorecard, was itself about to be disrupted by Google (Nasdaq: GOOG  ) .

At the time, The Big G was building a content delivery network for YouTube videos. Why would anyone do business with Akamai, the thinking went, if mighty Google were already delivering the Web's most popular video content?

Investors got noticeably worried. Months earlier, Amazon.com (Nasdaq: AMZN  ) and AT&T (NYSE: T  ) had announced plans to build their own content delivery networks (CDN). AT&T even suggested that its CDN would deliver TV to iPhones.

By November, a month before Google got serious about video delivery, shares of Akamai had fallen to just $9.25 a share.

Fed by the video feed
Fast-forward to last Friday. That's when two analysts upgraded Akamai after observing strong trends in its business, including an improving outlook in its e-commerce operations. Citigroup also cited the emergence of high-definition video on the Web as a revenue opportunity for Akamai, parroting an earlier pitch made by CEO Paul Sagan.

Akamai has since revised its fourth-quarter guidance to $0.42 to $0.43 in adjusted per-share profit, on $230 million to $235 million in revenue. Earlier estimates had called for $0.39 to $0.41 per share on $217 million to $224 million in revenue, Dow Jones reports. The stock closed at $25.09 yesterday, up more than 170% in a year.

So much for getting Googled.

Cutting to grow?
Yet if Akamai's competitive position is improving versus peers such as Level 3 Communications (Nasdaq: LVLT  ) and Limelight Networks (Nasdaq: LLNW  ) , it may owe as much to aggressive pricing as to value-added services such as advertising delivery. That's what industry watcher Dan Rayburn found when talking with Akamai customers at last month's Streaming Media West trade show.

"Content owners currently with Akamai said Akamai had dropped their pricing to be near Limelight's and Level 3's and in some cases, was matching their pricing for renewals," Rayburn wrote in this blog post.

He's referring specifically to pricing around video delivery, a growing business in which CDNs are playing an increasing role. For example, Akamai now delivers high-quality video to the iPhone -- sorry, AT&T -- while Limelight delivers Watch Now videos on behalf of Netflix (Nasdaq: NFLX  ) .

I want my MT ... I mean, YouTube!
We haven't yet seen big money made in online video, but there's evidence of an emerging business here. Nielsen reports that during the third quarter, consumers spent 35% more time watching video on the Web than they had a year ago. TV consumption fell slightly over the same period.

Numbers like that will attract advertisers, and Akamai wants a huge slice of the resulting pie. Aggressive pricing is the cutter. Here's why I have no issue with that as an investor:

Company

Gross Margin
TTM*

Gross Margin
2008

Gross Margin
2007

Akamai Technologies

75.7%

76.9%

77.7%

Level 3 Communications

58.3%

57.9%

57.1%

Limelight Networks

55.4%

55.1%

56.5%

Source: Capital IQ, a unit of Standard & Poor's.
*Trailing 12 months.

Yes, Akamai's gross margin has been falling, but looking at the table, I still see quite a lot of leverage in the business. More than enough, I'd say, to use price cuts as a blunt instrument in a war with its more commoditized rivals.

The timing also couldn't be better. BT Group is now working with other British Internet Service Providers to create an open network for delivering Web videos quickly and reliably in the U.K., Reuters reports. Akamai is in their sights.

"This shift by Akamai to adjust their pricing strategy is a smart one; I just don't know why it took them so long to do it," Rayburn wrote. I agree.

Now it's your turn to weigh in. Should Akamai continue to be aggressive in its pursuit of Web video delivery business? Please vote in the poll below. You can also sound off in the comments box at the bottom.

Amazon and Netflix are Stock Advisor selections. Akamai and Google are Motley Fool Rule Breakers recommendations. Try any of our Foolish newsletter services free for 30 days.

Fool contributor Tim Beyers is a member of the market-beating Rule Breakers stock-picking team. He owned shares of Akamai and Google at the time of publication. Check out Tim's portfolio holdings and Foolish writings, or connect with him on Twitter as @milehighfool. The Motley Fool is also on Twitter as @TheMotleyFool. The Fool's disclosure policy has visited pubs in London, but oddly has done its best pub-crawling in Brussels.


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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 December 09, 2009, at 3:42 PM, 5574tjh wrote:

    Did you listen to the Financial anayst conference-

    I still think anayst don't get that Akamai is more than a CDN,much more.

    Google does very little well-look at YouTubes videos

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