Akamai Technologies, Inc.

Moat: 2/5

Understandability: 3/5

Balance Sheet Health: 4/5

Akamai Technologies, Inc. is a cloud services provider, specializing in content delivery, cybersecurity, and edge computing solutions for a wide range of customers.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

Moat Analysis: 2 / 5

Akamai’s moat is relatively narrow, primarily built on its established infrastructure, robust network, and specific expertise in content delivery and cybersecurity. However, these advantages are increasingly challenged by cloud providers with extensive offerings, and other content delivery networks are constantly improving and adding new features. Here’s a breakdown:

  • Intangible Assets (Brand, Patents, Regulatory Licenses):
    • Akamai has a relatively strong brand in content delivery networks (CDNs) and is generally known as one of the pioneers in this space. However, in today’s crowded market with multiple players, its brand doesn’t command the same power as some other more recognized companies. There are a limited amount of patents and regulatory licenses, so we don’t see a sustainable moat in this category.
  • Switching Costs:
    • There are some moderate switching costs for customers using Akamai’s services, since many companies have integrated their content distribution and security needs into Akamai’s platform. Changing to another provider, would require not only time and effort but also substantial retraining and potential risk of disruption. It is not that sticky in their offering however.
  • Network Effect:
    • While Akamai benefits from a large scale network with many servers and access points, which increase service availability, the direct network effects are limited. More users do not necessarily make the network more valuable to each other. This makes it a hard category to create a moat around.
  • Cost Advantages:
    • Akamai’s scale allows it to spread fixed costs and improve operational efficiency, but in a highly competitive market there are always other players doing the same, and in most instances they are bigger. The cost advantage is not overly sustainable.

Overall Moat Rating: 2 / 5 While Akamai has some competitive advantages stemming from its infrastructure, they don’t seem strong enough or have enough barriers for competitors to be held back long term.

Business Resilience and Legitimate Risks:

Akamai faces several risks that could impact its moat and financial resilience:

  • Intense Competition: The CDN and security space is highly competitive with other players such as Cloudflare and Fastly. These companies are growing fast and eating into Akamai’s business. Moreover, large cloud providers such as Amazon AWS, Microsoft Azure, and Google Cloud are investing massively into their own CDN capabilities, which also compete directly with Akamai’s services.

  • Technological Obsolescence: Given Akamai’s focus on technological solutions, its business model may be rendered obsolete by newer technologies, which is a common risk in the ever-changing tech space.
  • Pricing Pressures: As the number of vendors in the space continues to increase, price competition becomes even greater, forcing Akamai to reduce its prices and squeeze margins.

  • Customer Concentration: A loss of a large customer could have a significant impact on the company’s revenues. Although it has a very diversified base, if the churn is high, it can significantly impact the business.

  • Geopolitical Risks: Like any company that has a global footprint, Akamai faces risks from macroeconomic conditions and trade wars, fluctuations in currency exchanges, sanctions or trade barriers. These can reduce the revenues significantly, even if operations continue normally. A global conflict, like the one happening in Ukraine, could severely influence the business.

Despite these risks, Akamai is generally resilient. It has a wide customer base, and a recognized brand, with a lot of experience in the market and a massive distribution network, so they are well set to handle some of the downside. Furthermore, the company is investing in security measures to protect from attacks, which should help protect its business.

Business Overview:

Akamai operates in three main segments:

  • Security Technology: This includes solutions for web security, DDoS protection, bot management, and application security. Its security products are focused on protecting websites and apps from attacks, fraud, and downtime, which are becoming important for companies worldwide, where risks of attacks are increasing greatly.
  • Delivery Technology: CDN services accelerate the delivery of content (like video, software, web apps) to users globally, reducing latency and increasing the viewing experience.
  • Compute Technology: These services are targeted to the development and implementation of distributed edge applications. The Edge technology can be deployed in servers around the world, which brings processing power closer to the end users.

Revenue Distribution:

  • Security is the biggest revenue contributor, and as shown in their latest reports, it makes up about 48% of the company’s revenue.
  • Delivery makes up about 40% of the company’s revenue.
  • Compute is the smallest of the categories, accounting for only about 12% of the revenues. However, the company expects a massive increase in revenues from Compute in the future.

Trends in the Industry:

  • Growing Need for Security: With the increase in cyberattacks and data breaches, companies are allocating more budget to cybersecurity products. This is a massive trend and something that will only increase in the coming years. This trend is a huge positive for Akamai’s revenue.

  • Cloud Computing: The growth in the cloud computing market means that edge and CDN services have become more critical. This will help grow their Compute and Delivery businesses in the long-term. However, this also presents increased competition from large cloud players.
  • Content Streaming: Increasing video and content streaming is driving demand for better delivery networks.
  • Growth in Edge Computing: As more applications move towards the edge, infrastructure supporting edge computing should be in high demand.

Margins:

  • Akamai generally has high gross margins, in the range of 70% to 80%. However, the operating margins are much lower, with an average margin around 20%. The operating costs are high, so the company needs to continue to focus on efficiency if it wants to increase profitability.

Competitive Landscape:

  • Akamai faces competition from:
    • Large Cloud Providers: Amazon AWS, Microsoft Azure, and Google Cloud.
    • Specialized CDN Vendors: Cloudflare, Fastly, and Limelight Networks.
    • Smaller Emerging Players: There are a number of upstarts trying to compete in this space and offer cheaper solutions.

What Makes Akamai Different?

  • Global Network and Scale: Akamai’s core competitive advantage comes from its massive worldwide infrastructure which is used for content delivery. The sheer scale and number of the locations are hard for others to replicate.
  • Specialization in Security: Akamai has been a pioneer in this space and is a well respected company. Also, the company is heavily investing into new security features.
  • Strong Enterprise-Client Relationships: Akamai has developed strong relationships with major corporate clients over the years, as many depend on Akamai to provide the internet service for their business.

Financials In-Depth:

Akamai’s financial performance can be broken down as follows:

  • Revenues: Their revenues have grown steadily at around 7 to 10 percent per year. While they are not seeing massive growth in revenues, they are adding customers and increasing the business every quarter. The current annual revenues are above 3.5 billion dollars.
  • Gross Profit: Their gross profit is excellent, around 70 to 80 percent. This gives a decent amount of flexibility for investments and growth.
  • Operating Income/Profit: The operating profits have seen some stagnation as the company spends more on sales, marketing, and R&D, but it’s still at a healthy profit level.
  • Net Income: The company has made some losses in the last few years, primarily because of major one-time charges. However, they have still been profitable overall and have a good history of profitability.
  • Cashflow: Akamai has strong free cash flow and is usually generating about 35 to 40 percent in free cash flow as a percentage of revenues.
  • Balance Sheet: Akamai has very low debt levels, which creates flexibility and gives the company a lot of strength. Also, the company has large cash holdings, giving them a strong balance sheet.

Recent Concerns and Issues:

  • Guidance: Akamai has lowered guidance multiple times for their future quarters. While some of this was due to macroeconomic factors, there is growing concern about the company’s profitability and growth, especially after many years of continuous growth. In Q3 of 2022, for instance, the company revised its annual revenue forecast downwards by 100 million dollars, while other large tech companies showed no drop in revenues. This has put a lot of investors in doubt, as it shows the company is falling behind its larger competitors.

  • Margins: The competition is fierce and is impacting Akamai’s margins. Also, due to rising operational expenses, the company will have to improve its operating leverage to maintain its profit.

  • Stock Based Compensation: Stock-based compensation is a significant expense, and they have not been properly diluted for many years. This has impacted the net income negatively. However, the company is actively reducing its shares via repurchase programs.

  • Customer Churn: It seems Akamai has had some issues retaining large clients in its customer base, which further adds to the risk of intense competition. Also, due to that, many mid and small-size businesses have left their product, which indicates that customer stickiness isn’t overly strong.

The management is trying to steer the ship in the correct direction by focusing on profitable projects, expanding its compute platform, and improving the sales team. The company expects that the economic benefits of their plans will be visible in the coming years.

Understandability: 3 / 5

Akamai’s business model is relatively complex, yet understandable. It requires some effort to fully grasp, because of the several layers of the services it provides. Also, there are many terms such as CDN, edge computing, cyber security, that are not always easily understandable for new investors, which make this a 3.

  • Business model: The company’s business model can be simplified to providing IT infrastructure and security for many businesses. It is quite complex in its functionality, but simple to understand at a high level.
  • Service offerings: The core services of providing delivery networks and protection against cyber attacks are easy to grasp, but technical details can be hard to understand.
  • Financial Metrics: The basic financial drivers such as ROIC, and FCF can be a bit complicated if the individual has little knowledge of finance.

Balance Sheet Health: 4 / 5

Akamai’s balance sheet is generally strong with very low levels of debt.

  • Low Debt: The company has very low levels of debt and a massive cash holding, which allows for flexibility and protection against uncertainty.
  • Strong Current Ratio: The company has almost three times the current assets for each one current liability. This is a strong position and a great safety net.
  • Solid Cash Flow Generation: Akamai has excellent cash flow, with a high free cash flow margin.

However, due to the company’s large share repurchase program, it has negative retained earnings. It is a very minor concern, and doesn’t pose much of a risk, but it still prevents the balance sheet from getting a perfect score. Also, their investment in long term securities and assets are slightly high. Therefore the balance sheet rating is 4/5.

In conclusion, Akamai is a valuable company in the internet services sector, with its long history and wide client base. However, its moat is eroding over time and new entrants are actively attacking its position in the market. Akamai needs to aggressively invest into new technologies and areas to maintain their market position in the long-term. The management seems intent in this endeavor, so long term results may be much more favorable than what they are experiencing right now.