Limelight Networks (EGIO 2.85%) posted ugly fourth-quarter earnings results last week. New CEO Bob Lyons has a plan to improve the content delivery network specialist's performance going forward, but that could create a significant challenge for the company: The changes mean Limelight will increasingly compete against the innovative and fast-growing players Cloudflare (NET 2.11%) and Fastly (FSLY 8.67%).
Disappointing fourth-quarter results
Limelight Networks' content delivery network (CDN) business is poised to grow over the long term. Indeed, with the digitization of enterprises and the secular increase in consumption of online services, users demand flawless digital experiences. And CDNs provide the computing infrastructure for enterprises to accelerate access to their online applications and services. In addition, with computing infrastructure located between users and online applications, CDNs have become an ideal area to implement cybersecurity features that protect online services from hostile actors.
Of course, such an appealing market attracts many competitors, and Limelight Networks differentiated its offering by focusing on large video streaming players. Its top 20 customers represented approximately 75% of revenue during the fourth quarter.
With that strategy, Limelight Networks sacrifices gross margin for lower operating costs, such as sales and marketing expenses. Indeed, large customers command lower prices because of their high traffic volumes, which diminish gross margins. But addressing those few large customers reduces sales and marketing expenses compared to the resources needed to acquire many smaller customers.
But during the fourth quarter, that strategy backfired. Despite a favorable environment with the launch of many video streaming services last year, which led to record quarterly traffic volumes, revenue declined 8% year over year to $55.4 million. During the earnings call, management explained the renegotiation of contracts with a few large customers and the increased traffic volumes led to unfavorable pricing.
In addition, the company's disappointing performance contrasts with the strong 10%, 40%, and 50% revenue growth of competitors Akamai Technologies (AKAM 0.43%), Fastly, and Cloudflare, respectively, during the same timeframe, which suggests Limelight Networks' offering isn't competitive enough.
To improve performance going forward, Lyons announced a plan that consists of enhancing the company's offering to drive prices up while controlling costs. Yet I expect significant challenges along the way.
By improving its offering, Limelight Networks will be increasingly competing against the innovative players Cloudflare and Fastly.
In particular, it will be extending its business with cybersecurity capabilities. Given the synergies with its CDN infrastructure, that makes sense. But most competitors got a head start and have been deploying cybersecurity features over the last several years.
For instance, Akamai's security business exceeded $1 billion last year, and it forecast that business to grow by 18% to 20% in 2021. Also, Cloudflare announced many extra cybersecurity features over the last several quarters. And Fastly acquired Signal Sciences in October to enhance its cybersecurity offering and leverage its CDN platform.
In addition, because of its weak top-line results, Limelight Networks' scale is diminishing relative to Fastly's and Cloudflare's. And it pales in comparison to Akamai's with trailing-12-month revenue of $3.2 billion.
That means Limelight Networks won't be able to outspend its competitors on research and development and sales and marketing expenses to gain market share while reaching Lyon's goal of improving profitability.
Besides, the company will also be looking to address the mid-market to reduce its exposure to its concentrated customers. However, that means it will certainly boost its research and development and sales and marketing expenses to increasingly compete against Fastly and Cloudflare -- a risky strategy that will require flawless execution to succeed.
In addition to the weak quarterly performance, Lyons, who took over two weeks ago, preferred not to give any guidance before he could better assess the business. That precipitated Limelight Networks' stock 13% lower. It's now trading at a modest price-to-sales ratio of two, which pales in comparison to Fastly's and Cloudflare's lofty ratios of 38 and 60, respectively.
That doesn't mean Limelight Networks' stock represents a bargain, though.
A part of that huge valuation gap is due to Fastly's and Cloudflare's superior performance. And Limelight Networks will remain in an unfavorable position to compete against those innovative players because of its smaller scale and significant delays in offering extra services such as cybersecurity.
Thus, investing in the tech stock remains a highly risky bet prudent investors should avoid. Instead, if you're looking to get exposure to the tech industry, you should consider these three top tech stocks.