Content-delivery networks (CDN) veteran Limelight Networks (NASDAQ:LLNW) crashed on Friday due to a disappointing earnings report on the evening of Thursday, February 11. The company missed Wall Street's fourth-quarter targets across the board, and analysts were quick to shower the stock in downgrades and lowered price targets. Limelight's stock fell as much as 28.7% on Friday morning and is now trading near three-year lows.
Let's see what went wrong in the fourth quarter. As a Limelight shareholder, I need to know whether these issues are fixable and temporary or structural and here to stay.
Limelight's quarter by the numbers
In the fourth quarter, Limelight's revenue fell 6% year over year to $55.4 million. Adjusted net losses increased from $0.01 to $0.03 per diluted share. Your average analyst had expected positive earnings of roughly $0.02 per share on sales near $61.4 million.
Management declined to provide guidance targets for the next quarter or for the 2021 fiscal year. CEO Bob Lyons was brought onboard just a couple of weeks ago, and Limelight is knee-deep in evaluating its strategy, business processes, and cost structures. Coming up with reasonable financial-guidance targets under these circumstances would be difficult, at best, and more generally a waste of resources.
The story behind the financial failings
As expected, Limelight saw record network traffic in the fourth quarter. The company's largest clients have launched popular video-streaming services, and Limelight's CDN services are often crucial to their operation. A new generation of gaming consoles also boosted the demand for large-scale download services. That sounds like a golden situation for Limelight's business, but it's not that simple.
Limelight is not the only provider of CDN capacity, and the surge in demand has created intense price-based competition for the largest video-delivery contracts.
"The good news/bad news is that we participated in accelerated growth with our customers but the volume of delivered content has driven many of them to exceed the contractual terms that they had agreed to," said CFO Dan Boncel in a call with The Fool. "Some of them came back to us even if they hadn't exceeded their contractual terms and said, 'we anticipate a ton of growth going forward but we need you to help us be more profitable."
Limelight considered each one of these requests and agreed to lower payment rates for some while letting others go to lower-priced rivals. These renegotiated contracts led to disappointing top-line sales and operating margins in the fourth quarter.
Is this fixable?
Boncel said that "the new Limelight" needs to offer better network performance and value-added services that can set the company apart from the competition. Edge compute services will play an important role in this effort, and network security services could also boost Limelight's profit margins. The company is listening to the needs of its leading customers in order to develop and deploy new products and services that can fit those requirements.
Lyons outlined a three-part strategy to pull Limelight out of the brewing price wars. The company needs to improve its core CDN business, expand that business to a wider population of target customers, and extend the business relationship with each customer to include a richer mix of value-added services.
The $100 million capital injection of last summer should help Limelight achieve these goals, but the company hasn't put that cash reserve to work yet. Simply adding network capacity could be a bad idea, throwing good money after bad, since Limelight also needs to find paying customers for its increased computing and delivery capacity.
For example, the company added several terabits per second of CDN capacity in South Korea last year, only to see the intended customer back down from its network-intensive business ideas. Most of the newly added capacity in South Korea is sitting idle now. Limelight needs to avoid costly and ineffective missteps like this one.
Is Limelight a buy or a sell today?
What Lyons and Boncel are talking about sounds like CDN Services 101. If you build a better service, the customers will come. Negotiating more profitable contracts is a natural part of that process. So it all comes down to execution of the new management team's long-term plans, which are in an early stage of development but seem to be headed in the right direction.
At this point, I wouldn't exactly recommend that you back up the truck and load it up with Limelight shares, but I'm not selling my shares, either.
Limelight's new management should be given some time to put their business plan in motion. Selling the stock today only locks in share prices at a level that assumes the worst of all possible outcomes. Knee-jerk reactions to bad news is not good for your portfolio's health because it's hard to make money when you buy high and sell low.
I'll wait and see how Limelight's revamped strategy crystallizes over the next couple of quarters. Limelight is serving a high-octane growth market, and there's a lot of potential value here waiting to be unlocked.