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Admiring Akamai
Board: Akamai Technologies, Inc.

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By whatismyoption
April 30, 2007

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I have long admired Akamai and the only fault I have ever found with them is valuation. With the recent decline of 25% from the recent high I thought it would be a good time to check back in on Akamai's valuation. I want to see if this is the time to buy back in to one of my favourite Rule Breaker companies.
So let's have a look at some of the numbers:

 

   
          Revenue        Operating   Operating GAAP   Normalized
                         Income      Margin    EPS    EPS
-----------------------------------------------------------------
Q1 2007   139,270        27,151       19%     0.11    0.28
Q4 2006   125,703        26,403       21%     0.12    0.27
Q3 2006   114,950        21,761       19%     0.08    0.24
Q2 2006   100,649        17,293       17%     0.07    0.20
Q1 2006    90,825        17,649       19%     0.07    0.17
Q4 2005    82,657        21,064       25%     0.16    0.16
Q3 2005    75,602        18,798       25%     1.71    0.14
Q2 2005    64,649        17,166       27%     0.11    0.12
Q1 2005    60,095        16,347       27%     0.10    0.10
Q4 2004    57,576        14,567       25%     0.10    0.10
Q3 2004    53,286        13,465       25%     0.08    0.09
Q2 2004    50,786        12,627       25%     0.05    0.07
Q1 2004    48,367         8,308       17%     0.02    0.04 


Revenue has been consistently growing at over 50% per year and normalized earnings have been growing at the staggering figure of almost 70% yoy. It is no wonder AKAM is such a fan of normalized earnings, they display an amazing consistent growth, especially compared to GAAP earnings. However, it is a shame that over half the difference between GAAP and normalized is stock compensation. The operating margin is healthy; however, I am surprised that it has not been expanding. I had still been working under the belief that Akamai's model was one of high fixed costs and low variable costs, resulting in more of the growing revenue falling to the bottom line. That assumption just looks untrue when I look at the figures, bummer dude. Though the growth is still outstanding.

Earnings can of course be easily manipulated and normalized earnings even more so; therefore, let's look at some more metrics.

   
        Operating      Capex      Free Cash   Cash King
        Cash Flow                   Flow      Margin
---------------------------------------------------------
Q1 2007    56,278      22,000(1)     34,278      24.6%
Q4 2006    22,570      18,994         3,576       2.8%
Q3 2006    48,490      13,519        34,971      30.4%
Q2 2006    27,746      10,733        17,013      16.9%
Q1 2006    33,161      13,556        19,605      21.6%
Q4 2005    27,763      5,828         21,935      26.5%
Q3 2005    20,499      5,937         14,562      19.3%
Q2 2005    15,924      7,584          8,340      12.9%
Q1 2005    18,702      7,598         11,104      18.5%
Q4 2004    15,575      4,948         10,627      18.5%
Q3 2004    14,548      3,436         11,112      20.9%
Q2 2004    12,478      2,730          9,748      19.2%
Q1 2004     8,636      1,228          7,408      15.3%


(1) I have estimated capex for Q1 07.
A cash king margin of over 10% is considered good, so AKAM is certainly excellent by that score. The worrying item here for me in capex, it seems Akamai is on a continuously escalating server spending spree.

Let's pull out a little and view the figures as a year on year (YoY) percentage increase/decrease with FCF also from a trailing twelve months (TTM) perspective.

           Rev    GAAP  Normalized    FCF   TTM FCF
-------------------------------------------------------
Q1 2007    53%        57%      65%     75%     39%
Q4 2006   52%       -25%       69%     -84%    34%
Q3 2006   52%       -95%       71%     140%    110%
Q2 2006   56%       -36%       67%     104%    78%
Q1 2006   51%       -30%       70%     77%     51%
Q4 2005   44%        60%       60%     106%    44%
Q3 2005   42%      2038%       56%     31%     --
Q2 2005   27%       120%       71%     -14%    --
Q1 2005   24%       400%       150%    50%     -- 


All those increases look fantastic with the exception of GAAP earnings. Revenue gains are still accelerating, normalized earnings are expanding even faster and FCF is expanding at a healthy clip.

All of this numbers confirm what I already knew, Akamai is in the tornado, they are growing at a fantastic clip, but what about their valuation.

Valuation
From yahoo P/E of 118.21 is derived from share price of 44.80 divided by ttm GAAP earnings of $0.38. The forward P/E of 26.05 is based on 2008 analysts' earnings estimates of $1.71. One of those figures is based on known GAAP data the other is based on normalized estimates from over 20 months away. So even if Akamai meets analysts' estimates of $1.71 for 2008, the GAAP earnings will be considerably lower and the actual P/E at that time considerably higher, assuming the share price is still the same. My point is I don't put any weight in the forward P/E.

With Akamai I have generally focused more on the normalized earnings, but as so much of the difference is based on stock-compensation I no longer feel that is a good measure. However, for those interested using normalized earnings the P/E is around 45.

On a FCF basis I calculate a ratio of 91. Ouch.

Is PEG a better measure for AKAM? Yahoo pegs PEG at 1.04 which places AKAM as fairly valued and probably a good buy. However, that figure is based on 5 year growth rates of 35%; a figure I don't place much faith in despite Akamai's fantastic growth. I like Akamai, the growth in online delivery and applications will certainly be at least 35%, probably more; however, I doubt that Akamai will grow their GAAP earnings or their FCF at that rate for the next 5 years.

I just can't get my head around a valuation on Akamai. In the short term their pps is based on what investors are willing to pay. What are you willing to pay?

If I had more time I'd try and do Enterprise Value (EV) to True Free Cash Flow (FCF), EV to Maintenance FCF and EV to Structural FCF. Without looking my guess is all those numbers would also be scarily high.

I just can't see any margin of safety with Akamai and yet I would love to own what I view as one of the best growth stories around. I see almost everything converging on to one network and I see Akamai as the leader in the delivery of that content, but there are a lot of risks. I do like growth, but I'd prefer to put my money at less risk and I'll hold out looking for lower prices.

After all of this I wish I could just trust Technical Analysis and look to buy Akamai when the charts tell me to do so. Charts courtesy of IncessantRambler.
AKAM daily chart: http://tinyurl.com/2mws6z
AKAM weekly chart: http://tinyurl.com/2kevub


There is no doubt of Akamai dominance, check this page out to get the low down. http://www.akamai.com/html/about/facts_figures.html

Earnings Releases
Q1 2007 http://www.akamai.com/html/about/press/releases/2007/press_042507.html
Q4 2006 http://www.akamai.com/html/about/press/releases/2007/press_020707.html
Q3 2006 http://www.akamai.com/html/about/press/releases/2006/press_102606.html
Q2 2006 http://www.akamai.com/html/about/press/releases/2006/press_072606.html
Q1 2006 http://www.akamai.com/html/about/press/releases/2006/press_042606.html
Financial Reports
http://www.akamai.com/html/investor/financial_reports.html
http://www.akamai.com/dl/investors/metrics_q107.pdf Summary financial data

Articles of Interest
Free Cash Flow http://www.fool.com/portfolios/rulemaker/1999/rulemaker991210.htm
Free Cash Flow http://www.fool.com/investing/dividends-income/2005/12/29/foolish-fundamentals-free-cash-flow.aspx


Cheers
Dean


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