To The Moon

• Shifting mix toward security solutions and Infrastructure as a Service (IaaS).
• Moving away from mature products like CDNs (Content Delivery Networks) toward more edge offerings.
• Countering employee stock-based dilution with $1.4 billion in authorized buybacks.
• Strong 3–5-year growth rates on computing and security segments more than offsetting modest declines in CDN.
• Increasing deal size and increasing add-on services.

Investment Thesis

Akamai$Akamai(AKAM)$ is a technology firm specializing in cloud computing and security. Akamai is shifting its mix to reduce its reliance on content delivery and moving toward being a security and computing-centric company. As a result, nearly every single top company employs Akamai in some form.

In 3Q22, Akamai repurchased 1.8 million shares at a total cost of $163 million. The current authorization has $1.4 billion remaining and will offset dilution from stock-based employee compensation and have a net reduction of shares. Akamai has reduced its share count by slightly more than 1% per year.

Akamai is targeting 13-15% of segment revenues toward capex, with the exception of the Security sector which requires much less capital investment at 3% of revenues. On a per segment basis, 6% of segment revenues are targeted toward R&D.

As of 3Q22, this number for the whole company is 14.7% of revenues going toward capex, and R&D running 11% of revenues. The biggest growth drivers are expected to be security innovations and the value-added proposition of the compute service. Margins are not expected to change with the shift toward security and computing, but revenue growth is expected to be around 10%. In 3Q22 Akamai saw 7% revenue growth and normalized EPS at $1.26.

Estimated Fair Value

Estimated Fair Value = E24 EPS (Earnings Per Share) times PE (Price/EPS)

EFV = E24 EPS X PE = $6.50 X 17.0x = $110.50 per share

We utilized the low end PE at 17. If Akamai can accelerate its revenue growth with security and compute, it could be rerated higher.

Compute and Linode Acquisition

In March of 2022, Akamai announced its buyout of Linode had closed. Linode is an alternative cloud provider centered around small business customers and developers. Linode consistently ranks as one of the easiest to use cloud providers. This adds to the small and medium sized enterprise customer base which makes up under 30% of Akamai’s revenue. Of firms surveyed, 61% of organizations plan to optimize cloud costs. Most of the largest cloud providers focus intensely on scalability and full capability of systems. Transparent pricing and a simple-to-use architecture is attractive to companies trying to optimize expenditures.

Leveraging the existing customer base of enterprise clients could add incremental customers to Linode. 91% of surveyed enterprises are open to using a multi-cloud approach. Developers conduct 73% of purchasing decisions at the enterpriselevel, and Linode is of use has made it a developer favorite. Linode has a very attractive cost to performance ratio for smaller jobs that do not need scaling. Linode will bolster the computing division, with all Linode’s existing service locations so far integrated into the Compute division. These are in addition to the 13 additional planned sites, with 5 going online in 1Q23 and 8 going online in 2Q23.

Compute is expected to take the forefront of Akamai’s business and future Capex spending will reflect this. Cloud computing is globally a $100+ billion industry, growing quickly. The Computing division expects a 30% CAGR over the 3–5-year medium term. In 3Q22 Compute’s revenue was up 77% year over year which was by far the strongest in the company. In FY21, Compute made up 7% of revenues, and by FY26 it is expected to increase to 30% of revenue.

Security

Global cybersecurity is booming, with attacks becoming more frequent and more complex. Akamai estimates that cyber-attacks routed through applications and APIs have increased over 5-fold year over year. According to Forrester, a technology-security consulting firm, 63% of organizations had experienced a breach in the last year with 45% of those breaches caused by an error from a 3rdparty vendor. To put this into scale, the average attack size is up 273% in the Americas and 200% in Europe since COVID-19. Akamai alone has seen a 196% increase in year over year in attacks, with 6 billion individual incidents in 1Q22 alone.

Gartner, another technology consulting firm, and Forrester both rank Akamai as the “most mature” of the cyber-attack mitigation offerings from competitors. Security added some significant customers in 3Q22, concentrated within the energy and banking sectors. CAGR over the 3–5-year horizon is expected to be 20%, and in 3Q22 Security’s revenues were up 19% year over year. Currently security makes up 39% of revenues, expected to rise to 50% by FY26. Security is expected to become the largest business segment replacing Content Delivery in importance and capital investment.

Content Delivery

Content delivery is the mature legacy business of Akamai. In 1H22, Akamai hit an all-time traffic record, reaching 250 terabytes per second in traffic on the network. Akamai was a partner for the world cup for both German broadcaster ARD and British broadcaster ITV.

Delivery’s results in 3Q22 were down 11%, which has allowed Akamai to reposition capex away from the Delivery segment toward Security and Compute. While Delivery remains a large portion of revenue and Akamai remains an industry leader, Akamai is repositioning itself away from the Delivery segment. In 3Q22, Delivery made up 45% of revenues but is expected to shrink to 30% by 2026. This implies a revenue decline of around 5% per year for the Content segment.

Risk

Historically, the Content Delivery business has been the largest and most prolific of Akamai’s products. While we believe in the shift toward cloud and security, we also recognize that moving away from the most successful products may not be successful. Both of these areas have intense competition, and Akamai is not the leader in these areas as it was in Content Delivery.

Competitive Comparisons

 https://buildingbenjamins.com/stock-thoughts/akam-trusted-in-security-moves-into-iaas-sector/