I'll be selling our personal stake in Akamai (Nasdaq: AKAM) next week, after the end of my three-year contest with Mr. Market to see who can create the most value for investors. (Find the scorecard here.)
This isn't an easy decision for me. Were it not for Akamai, I'd never have been hired to write for the Fool. Nor would I have earned a spot on David Gardner's Motley Fool Rule Breakers team. Much of what I owe for my Foolish career, I owe to Akamai.
Yet I also owe it nothing. After a decade of investing, the most important lesson I've learned is that stocks aren't sports teams you cheer for. They're stubs, signifying a slice of ownership in a business. Value the slice properly, and you earn returns. Value it poorly, and … well, you were there for the Lost Decade. I no longer believe Akamai is valued for outsized returns compared with the other stocks on our Rule Breakers scorecard.
Promises unkept
In February, management said signing long-term yet lower-cost traffic deals with Netflix (Nasdaq: NFLX) and other signature clients -- while negative over the short term -- would lead to accelerating second half-growth. Here's how CFO J.D. Sherman put it in Akamai's fourth-quarter earnings call:
We are maintaining our objective of 15% plus growth for the year. The seasonal step down of revenue in Q1, combined with the timing of a large number of renewals, the achievement of that objective is dependent on an expected business growth in the back half of the year. Longer term, we think the traction we've demonstrated in 2010 coupled with the investments we've made positions us very well for growth in the second half of the year and beyond. [Emphasis added.]
Given these comments, investors rightly believed that big-volume media deals would lead to healthy traffic gains and at least 15% revenue growth for the full year. Instead, we got these comments from Sherman during Wednesday night's Q2 review:
We started to see some positive signs on traffic growth. But so far, we have not seen a significant enough uptick in the rate of growth to offset the typical unit pricing decline in our industry and support achievement of our 15% revenue growth objective for 2011. … At this point, we think the most likely range for revenue growth for the full year is 10% to 13%. Specifically for Q3, we expect revenue in the range of $273 million to $283 million or 8% to 12% year-over-year growth. [Emphasis added.]
In other words:
- Traffic growth isn't accelerating as quickly as management had hoped for.
- Value-added services, though growing rapidly, aren't enough to overcome a traffic shortfall in Akamai's legacy-media and software-delivery business.
The growth that made Akamai a Rule Breaker has gone missing, stolen, it seems, by the likes of Cotendo, EdgeCast, Level 3 Communications (Nasdaq: LVLT), and Limelight Networks (Nasdaq: LLNW), which a few months back beat a patent lawsuit Akamai brought against it years ago.
Probation can last only so long
I've had Akamai on probation since February, when reports first surfaced of competitors that were pricing their way into volume traffic deals at Akamai's expense. In May, I identified two challenges that management would have to show signs of overcoming by the time of the Q2 report.
First, I said management would have to put a stop to margin erosion. That didn't happen. Value-added sales to enterprise and commerce clients may have been up 28% and 21% year over year, but GAAP gross margin fell 3 percentage points over the same period. High-margin sales aren't doing enough to counterbalance price cuts elsewhere.
Second, I said revenue growth would have to reaccelerate as promised. It hasn't. Instead, Akamai's 10%-13% projected top-line gain for 2011 would count as its worst performance since 2009, when growth dipped into the single digits. The stock followed suit.
A time to buy, and a time to sell
To be fair, Akamai regained much of its momentum last year and could do so again. I'm hopeful for the sake of existing investors, Rule Breakers members, and the good people at Akamai. There's a lot to like about the company; there isn't enough to like about the stock.
That's why I'm selling. Not with malice, nor regret -- though maybe with a touch of sadness. You've been great to me and to Rule Breakers subscribers who bought into our first recommendation in May of 2005, but -- for now -- it's time to say goodbye, Akamai.
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