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Akamai Technologies, Inc.
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By tbeyers
December 11, 2003

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All,

After 619hudson's reply, and now the news of MORE convertible notes, I thought I'd do some additional digging into the AKAM financial story. Here goes:

The convertible notes are indeed a burden. According to page 25 of the third quarter 10 Q Akamai pays $16.5 million per year in interest on its notes ( go here for a copy from Edgar.)


That's $4.125 mil per quarter. Not good.

619hudson is right. If the notes were to be converted, or refinanced by the issuance of more stock to raise cash, then dilution would rise far above the historic 2 percent rate (measured over the past three years).

But let's be clear: Akamai's financial situation is improving. Nearly every operating expense has been reduced on a quarterly basis except for interest payments.

Restructuring charges, which have shown up on the income statement every quarter but aren't really operating expenses, have stabilized. According to page 18 of the latest 10Q, total restructuring charges of $9 mil remain. I'm not seasoned enough to tell you all how these charges will be attributed to future operations.

Still, I like the way Akamai's income statement is improving. Operating expenses as a percentage of revenue dropped in Q3 to 78.91% from 93.11% the quarter before. The 15-point boost demonstrates serious momentum towards profitability. A blowout fourth quarter might actually show positive operating and net income.

If AKAM were to hit the high end of its guidance range and book $45 million in sales while reducing interest, SGA or COGS, then positive operating income is not only possible but also probable. Bear in mind that AKAM has beaten Street expectations for the past three quarters.

It's also instructive to look at Akamai's cash situation. As 619hudson suggests the Akamai cash burn rate has been somewhat frightening during 2003 � dropping to $83.9 mil in the latest quarter from $111.26 mil at the end of last year. That's $27.46 mil in nine months.

But it's not enough to just look at the balance sheet. Flip again to page 18 of the latest 10 Q and you'll see that Akamai has spent $20.1 mil in cash for restructuring leases and reducing other ongoing expenses. This is a great use of cash.

Even better is that the spending hasn't hurt AKAM's working capital, which has been near or above $70 mil for the last three quarters.

The big question for me is this: when will AKAM see positive cash from operations and free cash flow? Honestly, it's difficult to tell. Fortunately, the discussion of operations and footnotes in the latest 10 Q reveals:

1. Restructuring is nearing completion. The hefty restructuring expenses that have hindered cash flow in 2003 should be much less in 2004.

2. Accounts receivable are improving. A note on pages 8 and 9 of the latest 10 Q says that one customer � probably Microsoft � had accounted for roughly 25 percent of receivables, or more than $6 million. The note goes on to say that "a majority of this balance was paid in October 2003." That sounds to me like a $4 to $5 million check. If this comes directly out of receivables then cash flow will improve correspondingly. Nice.

3. AKAM's losses are narrowing substantially, as noted above.

The only potential issue is that depreciation benefits will continue to decline, leading to a much lower credit in this area on the cash flow statement in the future. But overall it appears that free cash flow may not be more than three quarters away.

Now, what about the existing and new notes?

The existing $300 mil worth of 5 1/2% convertible notes come due in 2007, but footnote 11 of the 2002 10K indicates that Akamai may redeem the notes at its option after July 3, 2003. Go here for a copy of the 2002 10 K.

Combine that fact with this note from page 25 of the latest 10 Q: "Our 5 1/2% notes are trading at a discount to their face amount. Accordingly, in order to reduce future cash interest payments, as well as future payments due at maturity...we may repurchase outstanding 5 1/2% notes for cash; exchange notes for shares of our common stock, debt or other consideration; or a combination of any of the foregoing."

And then read this statement from the paragraph above on the same page: "...our 5 1/2% notes, do not restrict our ability or our subsidiaries' ability to incur additional indebtedness, including debt that ranks senior to the 5 1/2% notes."

In English: we can refinance anytime with lower interest debt that would get first share of the pie if we had to liquidate.

This leads me to the latest announcement, of $175 mil more in convertible notes. On the surface, this looks like awful news. What shareholder wants more dilution?

But as the notes above indicate, AKAM may just be refinancing its debt and saving 4 1/2 points in the process. The press release announcing the new offering seems to support this view: "The company intends to use the net proceeds of the offering for working capital and general corporate purposes, which may include repayment or redemption of a portion of its current outstanding indebtedness."

Existing note holders may want to trade up to the new bonds so as to stay first in the liquidation line while continuing to earn interest. If AKAM's stock jumps then they earn the upside � although shareholders would be penalized.

Akamai has until Dec. 15, 2010 to pay off its notes without any conversions. For this next quarter and beyond I'd be looking to see if AKAM is able to create a net reduction in its long-term debt through the issuance of these notes. If so, I applaud the effort as sounds fiscal management and would continue to look for a buying opportunity for the stock.

If not, then I'll stay on the sidelines a while longer.

Viva la Fool!

Tim

NOTE: this write up is also available as a Word doc with tables showing the last 4 qtrs of operating income plus a specific projection for Q4. Please send me e-mail through this board if you want a copy.


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