Goodbye, Akamai

I'll be selling our personal stake in Akamai (Nasdaq: AKAM  ) next week, after the end of my three-year contest with Mr. Market to see who can create the most value for investors. (Find the scorecard here.)

This isn't an easy decision for me. Were it not for Akamai, I'd never have been hired to write for the Fool. Nor would I have earned a spot on David Gardner's Motley Fool Rule Breakers team. Much of what I owe for my Foolish career, I owe to Akamai.

Yet I also owe it nothing. After a decade of investing, the most important lesson I've learned is that stocks aren't sports teams you cheer for. They're stubs, signifying a slice of ownership in a business. Value the slice properly, and you earn returns. Value it poorly, and … well, you were there for the Lost Decade. I no longer believe Akamai is valued for outsized returns compared with the other stocks on our Rule Breakers scorecard.

Promises unkept
In February, management said signing long-term yet lower-cost traffic deals with Netflix (Nasdaq: NFLX  ) and other signature clients -- while negative over the short term -- would lead to accelerating second half-growth. Here's how CFO J.D. Sherman put it in Akamai's fourth-quarter earnings call:

We are maintaining our objective of 15% plus growth for the year. The seasonal step down of revenue in Q1, combined with the timing of a large number of renewals, the achievement of that objective is dependent on an expected business growth in the back half of the year. Longer term, we think the traction we've demonstrated in 2010 coupled with the investments we've made positions us very well for growth in the second half of the year and beyond. [Emphasis added.]

Given these comments, investors rightly believed that big-volume media deals would lead to healthy traffic gains and at least 15% revenue growth for the full year. Instead, we got these comments from Sherman during Wednesday night's Q2 review:

We started to see some positive signs on traffic growth. But so far, we have not seen a significant enough uptick in the rate of growth to offset the typical unit pricing decline in our industry and support achievement of our 15% revenue growth objective for 2011. … At this point, we think the most likely range for revenue growth for the full year is 10% to 13%. Specifically for Q3, we expect revenue in the range of $273 million to $283 million or 8% to 12% year-over-year growth. [Emphasis added.]

In other words:

  1. Traffic growth isn't accelerating as quickly as management had hoped for.
  2. Value-added services, though growing rapidly, aren't enough to overcome a traffic shortfall in Akamai's legacy-media and software-delivery business.

The growth that made Akamai a Rule Breaker has gone missing, stolen, it seems, by the likes of Cotendo, EdgeCast, Level 3 Communications (Nasdaq: LVLT  ) , and Limelight Networks (Nasdaq: LLNW  ) , which a few months back beat a patent lawsuit Akamai brought against it years ago.

Probation can last only so long

I've had Akamai on probation since February, when reports first surfaced of competitors that were pricing their way into volume traffic deals at Akamai's expense. In May, I identified two challenges that management would have to show signs of overcoming by the time of the Q2 report.

First, I said management would have to put a stop to margin erosion. That didn't happen. Value-added sales to enterprise and commerce clients may have been up 28% and 21% year over year, but GAAP gross margin fell 3 percentage points over the same period. High-margin sales aren't doing enough to counterbalance price cuts elsewhere.

Second, I said revenue growth would have to reaccelerate as promised. It hasn't. Instead, Akamai's 10%-13% projected top-line gain for 2011 would count as its worst performance since 2009, when growth dipped into the single digits. The stock followed suit.

A time to buy, and a time to sell
To be fair, Akamai regained much of its momentum last year and could do so again. I'm hopeful for the sake of existing investors, Rule Breakers members, and the good people at Akamai. There's a lot to like about the company; there isn't enough to like about the stock.

That's why I'm selling. Not with malice, nor regret -- though maybe with a touch of sadness. You've been great to me and to Rule Breakers subscribers who bought into our first recommendation in May of 2005, but -- for now -- it's time to say goodbye, Akamai.

Do you agree? Disagree? Weigh in using the comments box below. And if you're in the mood for more stock ideas, try this free video. You'll walk away with a better understanding of how cloud computing is reshaping industries and another winning pick from our Motley Fool Rule Breakers scorecard. Start watching now -- it's 100% free.

Fool contributorTim Beyers is a member of theMotley Fool Rule Breakers stock-picking team. He owned shares of Akamai at the time of publication. Check out Tim'sportfolio holdings andFoolish writings, or connect with him on Google+ or Twitter, where he goes by @milehighfool. You can also get his insightsdelivered directly to your RSS reader.

Motley Fool newsletter services have recommended buying shares of Netflix and Akamai Technologies. Motley Fool newsletter services have recommended buying puts in Netflix. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.


Read/Post Comments (9) | Recommend This Article (11)

Comments from our Foolish Readers

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 30, 2011, at 10:55 PM, jopow wrote:

    Are you now selling after the stock has dropped 50%?

    You make it sound like it is no big deal that you rode the stock down from $50 plus to $25.

    Why didn't you sell at the top.

    What is the stock worth then, if you go through this trouble to be critical and skeptical about the company?

    What is the bottom for the stock taking into account the least metrics this company can produce in the next 12-24 months?

    Also, what about that big insider purchase at $34 a few months ago, and the stock surged to $37 before it tumbled? Was that a big time mistake of that insider or what?

    Thanks for your opinion, but after you riding it down, I question why somebody should listen to you now.

  • Report this Comment On July 31, 2011, at 7:05 AM, analystsamazeme wrote:

    Here's the problem i'm having with the "fool" and it's writers...

    Go back and look at your articles for Akamai. You pumped and pumped the stock trying to justify why it should go up. You were hoping to increase interest to move the stock. Fortunately people already saw what you didn't see and stayed out. Why did it take you so long to realize and then sale?

    I would suggest to write about stocks you don't invest in because it's a "conflict of interest".

    Level(3)...guessing you don't own it but it put the dagger in Akamai. You should find out what companies led to this decision of selling because you should be buying them!

    Maybe I should write for the fool!

    Akamai...fools gold....lol! Again...research the companies that caused you to sell.

    Happy investing!

  • Report this Comment On July 31, 2011, at 8:35 AM, lojikfool wrote:

    Hi Tim,

    I think AKAM was the first Foolish purchase I made, in 2005 in the low teens. I took some profit and currently sitting at over 100% overall gains. The money I made from AKAM over the last several years went into other Foolish purchases which formed the basis of my avg 17% per year returns for the last 5 years - so I too owe a lot to AKAM and to you. I'm not going to sell yet though, they're still best in class in an industry segment that has decades of growth ahead of it. Don't worry about commoditization remember the level of technology we are talking about here, we're not talking about water pipes and pumps. Also don't foolishly sell low, keep the faith. We're all seen other holdings outperform for a while and sure it's painful but I think they'll be back.

    First rule of investing : Don't overreact to the headlines.

    Second rule of investing : Don't under react to the deadlines.

    Fool on.

  • Report this Comment On August 01, 2011, at 4:03 PM, NeuroProf wrote:

    In July 2011, the Three Kings of Cloud Computing still included AKAM...What gives?

  • Report this Comment On August 01, 2011, at 9:02 PM, SwiperFox wrote:

    Perhaps it's because "Cloud Computing" was so perfectly named, in an eponymous way. Cloud. Vapor. Wait...time for a haiku.

    Cloud Computing spring.

    Cloudburst drenches all below,

    Vapor and sunshine!

  • Report this Comment On August 02, 2011, at 11:26 AM, blackboxdow wrote:

    AKAM missed by a penny only.......22% haircut pretty steep.....but looks like dead money for a few quarters. The fools lived up to their name with AKAM. Cloud computing a bunch of hype!

  • Report this Comment On August 02, 2011, at 2:31 PM, gw2011 wrote:

    Seems too early to give up on Akamai:

    $277M revenue is on the upper end of guidance

    $0.35/share earnings at midpoint of guidance

    13% annual revenue growth is significant given all the global economic/political uncertainty.

    $400M cash generated yearly

    90,000 servers worldwide cannot be easily surpassed by competitors.

  • Report this Comment On August 03, 2011, at 4:55 PM, joed120017 wrote:

    I sold at 48 for no other reason than I bought at 14 and felt the stock got ahead of itself. Just bought 2 new positions at 29 and 23 and still feel the company is a sector leader and also has a chance to be taken over. If any of its competitors gets taken over, it will add to the value of AKAM.

  • Report this Comment On September 04, 2011, at 6:16 PM, ngerard wrote:

    Bought in at under $5 and have been on the AKAM ride for years and am going stay on it for a good while longer. If Google wants to see AKAM gone so bad, maybe they'll help get it acquired.

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