Why I Remain Unfazed After Limelight Networks' Epic Stock Price Drop

The wheels have started to come off the internet infrastructure stock party. Booming web traffic during the economic lockdown in the spring has started to moderate, and the first hyper-growth stock to be tamed was Fastly (FSLY -3.35%). Next up was Limelight Networks (EGIO 0.28%), which just endured a nearly 40% drubbing after posting third-quarter 2020 results mostly in line with its own expectations.

This is a small position for me, but I remain unfazed by the market's reaction and plan on adding a small amount more.

Even small deeds get punished

Limelight reported revenue of $59.2 million during the third quarter, up 15% from last year and in line with its updated guidance provided a few months earlier. Adjusted EBITDA (earnings before interest, tax, depreciation, and amortization) was $5.6 million, down 4% from last year. It was on the thin side of management's profit outlay, but it was nonetheless enough to keep Limelight on track for its full-year targets (revenue up 17% from 2019 at the midpoint of $230 million to $240 million, adjusted EBITDA up 74% from 2019 at the midpoint of $28 million to $35 million).

Image source: Getty Images.

Through the first nine months of the year, this small internet data delivery technologist is doing well considering its size relative to many much larger peers.

Data source: Limelight Networks. pp = percentage point. EBITDA = earnings before interest, tax, depreciation, and amortization.  

If results were in accordance with the guidance, why the epic stock price punishment? It seems it has to do with gross profit margin on services rendered. Limelight had previously stated its intent to get gross margin back to 40%, but that didn't transpire in Q3. Limelight's focus on large customers in the media industry seems to be the issue here, although the higher cost of revenue and depreciation (a non-cash item) on newly constructed infrastructure also took a toll in the period.  

As a reminder, some of the top users of Limelight's web traffic services are TV broadcast and streaming giants like Disney. The massive global scale of these players and their bargaining power may be what's keeping a lid on Limelight's margins. Backing out non-cash items, though, cash-only gross margin was a healthy 46.1% in Q3. While this is a metric to keep a close eye on, this small company has nonetheless been able to stay on track with its bottom-line goals for full-year 2020. I thus say the precipitous fall in share price -- currently sticking a market cap of only $483 million on Limelight and a valuation of just two times trailing 12-month sales -- is way overdone.  

A small company trading on the cheap

Granted, future success will continue to hinge on this internet content delivery firm's ability to expand, especially in the nascent edge computing arena. But I think Limelight's growth will continue. Web traffic is a secular growth trend that will last for the indefinite future, and the company has continued to add new customers in video, TV, and connected education services, among others. The raising of $110 million in fresh cash via convertible debt also bodes well for Limelight's chances at further success.

Nevertheless, this illustrates why I keep my emerging small-cap stock portfolio well-diversified and individual holdings as a small percentage of my total net worth. Having the room to purchase more -- if the thesis isn't busted -- is imperative when the inevitable wild moves ensue. That's just what has happened here, and I plan on adding to my position (though my total will still be about 0.5% of my portfolio). In the internet infrastructure race, Cloudflare (NET -1.05%) is the lead horse at the moment, and I'll soon reenter a position in Fastly as well to complement my small Limelight Networks bet. 

Of the three, though, it's tiny Limelight that presents a real bargain, given the company can maintain its rate of growth.