Shares of former Motley Fool Rule Breakers recommendation Akamai Technologies (Nasdaq: AKAM) are rallying big today, finishing the day up more than 15% on a good third-quarter earnings report. Color me glad. Many of our members have held in hopes of recovering losses incurred over the past year.
Yet while I'm happy for Fools who decided to stand pat, I also stand firmly by my decision to sell. Akamai isn't a Rule Breaker. The Q3 report and fourth-quarter guidance all but confirm it. How? Let's review the details in light of the six signs of a rebel stock that Fool co-founder David Gardner identified years ago.
1. A top dog and first mover in an important, emerging industry = yes
Though the evidence is mostly anecdotal, most accounts have Akamai as the market leader in Web-based content delivery. And the industry is important. The rise of cloud computing, data-hungry smartphones, and video streaming services creates a need for services that securely store and deliver information to users wherever they may be. Akamai is among the best at this.
2. Sustainable advantage gained through business momentum, patent protection, visionary leadership, or inept competitors = no
There are too many attractive alternatives. Back in June, industry watcher Dan Rayburn reported that some customers were switching to privately held Cotendo for higher-value video-delivery services that were to become Akamai's bread-and-butter. Juniper Networks (Nasdaq: JNPR) and Citrix Systems (Nasdaq: CTXS) invested in the business. One quarter later, continued erosion in Akamai's gross margin -- down 70 basis points sequentially and 240 basis points year-over-year -- suggests that customers don't mind switching.
Patents also haven't held up as well as they used to. A current suit against Cotendo is ongoing, but in 2009 a federal court reversed a patent ruling that at one time appeared to end the threat from upstart Limelight Networks (Nasdaq: LLNW).
3. Strong past price appreciation = no
Not this year -- or even most years. Shares of Akamai are down more than 42% year to date, 46% over the past 12 months, and 41% over the past five years. I was fortunate to buy in 2004, when the stock was still trading a little north of $10 a share. Others who bought when Akamai slipped into the single digits in 2008 have also enjoyed massive returns. Far too many more have lost to the market averages.
4. Good management and smart backing = yes
Others may not, but I believe in CEO Paul Sagan, who has been with the company since its infancy and who has deep experience in the media and e-commerce businesses that drive much of Akamai's revenue. Co-founder Tom Leighton is also still involved, and as a group, insiders own 2.9% of the shares outstanding. They've been net buyers since March. Institutions have seen a net increase in their positions over the same period, but only marginally so.
5. Strong consumer appeal = no
Akamai has never been one to attract consumer interest, though its business was much more consumer-oriented at one time. Value-added services now account for more than 50% of revenue -- a change that says, in essence, delivering songs and movies for Apple (Nasdaq: AAPL) doesn't matter as much as it once did. And while losing control of the Netflix (Nasdaq: NFLX) account to fiber-network operator Level 3 Communications (Nasdaq: LVLT) hurt, it probably wasn't the disaster some thought it would be.
6. A documented history of being viewed as overvalued = no
Neither the Street nor the Fools in our Motley Fool CAPS database have looked askew at Akamai's valuation for some time now. If anything, they look at its reasonable earnings multiple and wonder whether it's time to buy. My Foolish colleague Sean Williams put it best over the summer. "I personally added Akamai to my own portfolio last week after the company guided earnings down yet again. Consolidation hype is on the rise and the company continues to pace itself at a 13% growth rate, nothing to sneeze at with a forward P/E of also 13," he wrote at the time, and he's up nicely in the months since.
Magic 8-ball says ... not a Breaker
With only two out of six rebel attributes, I remain comfortable having sold my personal stake in Akamai and recommending members do the same.
I'll look a little silly today, I realize -- 10%-plus up days don't come around often. But I'm also willing to sacrifice a few points in the pursuit of the highest possible returns over decades. Our Rule Breakers scorecard reflects the power of this strategy, and I see no reason to deviate from it now.
Akamai may be a market leader. It may be cheap. It may even be one of the major beneficiaries of the shift to cloud computing. (I'll certainly be rooting for the latter.) But it isn't a Rule Breaker, and that means it no longer belongs in my portfolio. Do you agree? Disagree? Please weigh in using the comments box below.
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