I Was Wrong About Akamai

Sometimes you're wrong even when you're right. In my case, I was right to buy shares of Akamai Technologies (Nasdaq: AKAM  ) in 2004. I was right to recommend the stock to our Motley Fool Rule Breakers subscribers in 2005. But I was dead wrong to hang on when all signs pointed to an eroding competitive advantage.

From Breaker to Tweener
Akamai was never a cheap stock. I bought it and recommended it because I believed the Web would become a primary source for work, entertainment and commerce. Akamai, by acting as a traffic cop for directing and speeding traffic over the Internet, would add enormous value to the online experience -- value that vendors would pay a premium for, I reasoned.

And they did, for a while. Revenue had soared 45% annually through 2007. Normalized profits -- i.e., earnings adjusted for stock-compensation costs and other charges -- zoomed close to 60% annually over the same period. Competition wilted as Akamai became the go-to company for delivering files for the likes of Apple (Nasdaq: AAPL  ) and Microsoft (Nasdaq: MSFT  ) .

Yet there were warning signs, too. Gross margin fell from more than 80% in 2005 to less than 74% two years later. Early competitors clobbered by the dot-com bust had finally given way to a new breed, notably Limelight Networks (Nasdaq: LLNW  ) . I should've spent more time analyzing the impact competitors were having. Instead, I took management's word that Akamai didn't typically face rivals in bidding for business.

Education was a bigger barrier than competition when it came to growth, executives told me at the time. CEO Paul Sagan still says there's a preponderance of do-it-yourselfers who simply won't outsource Web-content delivery, no matter which vendor is pitching.

From Disruptor to Disrupted
Despite the signs, in November 2007 I insisted that Akamai wasn't nearly as expensive as most analysts believed. The company's proprietary software for determining the best path to route traffic over the Web could be tuned to create new services, I argued. Also, when you considered the growth analysts were expecting, Akamai was cheaper than most of its peers and Google (Nasdaq: GOOG  ) .

None of it mattered. The 2008 financial crisis took a heavy toll, forcing Akamai to cut staff as it faced off against new competition from Amazon.com (Nasdaq: AMZN  ) . That should have been a warning sign. While no company is fully immune from looming economic catastrophe, true Rule Breakers manage hypergrowth in even in tough times. Akamai looked normal even as I argued it was exceptional.

Yet I wasn't done. As 2009 drew to a close -- a good year for Akamai investors -- I returned to my soapbox, this time arguing that price cuts were good, so long as they helped stave off competitors. Lower returns on deployed servers didn't matter because Limelight and Level 3 Communications (Nasdaq: LVLT  ) lacked the balance-sheet strength for trench warfare. Akamai was a survivor, I argued, and would be 2010's best tech stock because of the rise of online video.

For a time it seemed I was right. Akamai more than doubled, starting the year above $48 a share. The 11 months since then have proved to be anything but kind. Disappointing first-quarter estimates and competitive losses in the streaming-media side of its business led investors to dump the stock.

Sagan and his team insisted that a combination of new deals, higher volume, and high-margin services would lead to a reacceleration in revenue and profit growth in the second half of the year, but they, too, were wrong. Seeing no other choice, I sold, and recommended Rule Breakers subscribers do the same.

3 things I learned
In hindsight -- always 20-20, I realize -- I still would have recommended Akamai but sold a lot sooner. Here are three specific ways my experience with researching and owning this stock have helped me learn as an investor:

  • Margins matter. True Rule Breakers so disrupt markets that they possess pricing power in both good times and bad. Consider Apple. Did the iEmpire cut iPhone prices as the world struggled to recover from the Great Recession? Nope. Akamai wasn't so fortunate, and I should have more carefully considered that when deciding whether to hold.
  • Competitive advantage isn't fleeting. Big Money venture capitalists never stopped pouring money into would-be Akamai killers. Some say they finally found one in Cotendo, which has teamed with Google on an open-source project for delivering content. Akamai has since sued and is reportedly working on a $300 million acquisition deal to retire the threat.
  • Valuation is never a good reason to buy a Breaker. Price matters in investing. But in this case, I let a cheap price blind me to structural faults with Akamai's business. I had forgotten a key tenet in our process -- that we look for stocks others believe are expensive on an absolute basis. We do this because history tells us that true Breakers form sustainable advantages that deliver tremendous growth, and correspondingly massive share gains, over the very long term.

In the end, I consider Akamai a successful failure. The stock that helped me clarify a process for investing in high-flying tech stocks and would-be Breakers. Sound like an intriguing approach? The Motley Fool recently published a special report that identifies the top opportunities in a trillion-dollar market in the making. Get your copy now -- the report is 100% free.

Fool contributor Tim Beyers is a member of the Motley Fool Rule Breakers stock-picking team. He owned shares of Apple and Google at the time of publication. Check out Tim's portfolio holdings and Foolish writings, or connect with him on Google+ or Twitter, where he goes by @milehighfool. You can also get his insights delivered directly to your RSS reader.

The Motley Fool owns shares of Microsoft, Apple, and Google. Motley Fool newsletter services have recommended buying shares of Microsoft, Apple, Amazon.com, and Google and creating bull call spread positions in Apple and Microsoft. Try any of our Foolish newsletter services free for 30 days. We Fools don't 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 (8) | Recommend This Article (6)

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 November 29, 2011, at 10:58 PM, bobyk3 wrote:

    You guys did the same with netflix. Recommended it at the peak!

    But is Amazon deserves to be in core stock? With a PE of 100, no stock should be a core. It is just an unwanted risk.

  • Report this Comment On November 29, 2011, at 10:59 PM, TMFNewCow wrote:

    Great recap, Tim. I was just a reader back then but followed AKAM via Rule Breakers. As tough as it is, always gotta learn from our mistakes!

    -- Evan

  • Report this Comment On November 30, 2011, at 12:25 AM, StockGuy1675 wrote:

    Great article. not. In the past, I've spent many of weekends with friends at the horse track who share your talent for seeing the past and preaching how they knew who the winner was going to be, but mistakeningly changed their mind at the last minute while at the betting window.. It's a gift to have 20/20 insight. Dope. Could of, would of. could of. What a waste of everyones time. You should put your money on red in Vegas. What a hack. And this is what passes as financial talent now a days. Throwing a dart at the stock summary stands a better chance of producing returns,

  • Report this Comment On November 30, 2011, at 8:58 AM, TMFMileHigh wrote:

    @bobyk3,

    >>You guys did the same with netflix. Recommended it at the peak!

    I made mistakes with Akamai but recommending at the peak wasn't one of them. The original rec in Rule Breakers soundly beat the market. The re-rec did not.

    @StockGuy1675,

    Is this really your response? This feels like a prank. If it's not, then either (a) you harbor the remarkably dangerous belief that stock analysts should be clairvoyant, or (b) you spent precious minutes taking a crack at me because you've got nothing better to do. Ouch.

    Allow me a quick follow-up so it's clear why I wrote this article and how I invest.

    I wrote the piece because I believe in learning from investing mistakes. I've made many, will make more, and seek to get better each time.

    The way I invest allows for not just small but HUGE misses. I take small bets on high-fliers first, adding only when I'm 100% convinced that I'm being well compensated for risk. The net effect of this approach is that my big losses are negligible in the context of our overall portfolio and are easily covered by my home runs.

    Thanks for the comments and Foolish best,

    Tim (TMFMileHigh and @milehighfool on Twitter)

  • Report this Comment On November 30, 2011, at 12:18 PM, Barrold wrote:

    Its not just Fools that have been wrong about AKAM. Many analysts were advising people to sell AKAM when the price was low and then to buy when the price doubled in about two months time. I scoffed at such advice about AKAM from the analysts, as I knew better that AKAM will continue to grow and offer more services outside of their traditional CDN offerings. Meanwhile I bought AKAM at about 19$ and sold at about 30$. Cha-ching$$ Maybe I should start blogging about stocks too? Its not that hard.

  • Report this Comment On November 30, 2011, at 12:52 PM, lucasmonger wrote:

    The author is dead wrong in the statement that Akamai was never a cheap stock. After their high flying dot-com days when the dot-bomb hit, I purchased at $1.09 and again at $0.89 per share.

  • Report this Comment On November 30, 2011, at 2:26 PM, TMFMileHigh wrote:

    @Barrold,

    Thanks for writing.

    >>Maybe I should start blogging about stocks too? Its not that hard.

    I would absolutely encourage you to hold yourself accountable in this way.

    It looks like you're new to site -- welcome! Rest assured it's easy to set up a CAPS profile and begin making picks. There's also a blogging feature available to all CAPS members.

    Foolish best,

    Tim (TMFMileHigh and @milehighfool on Twitter)

  • Report this Comment On November 30, 2011, at 2:32 PM, TMFMileHigh wrote:

    @lucasmonger,

    >>The author is dead wrong in the statement that Akamai was never a cheap stock. After their high flying dot-com days when the dot-bomb hit, I purchased at $1.09 and again at $0.89 per share.

    Unfortunately you're confusing low per price share with cheap.

    Though you undoubtedly bought well, you were buying when Akamai was unprofitable and trading for between 2.5 and 15 times revenue to enterprise value in the months following the dot com collapse. Neither of those multiples is cheap. Reasonable, sure, but definitely not cheap.

    Foolish best,

    Tim (TMFMileHigh and @milehighfool on Twitter)

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