Understanding Akamai

After the Akamai analyst conference the other day I was pretty enthusiastic and thought I might buy a bit of Akamai (AKAM) stock. The price shot up in after hours trading after the conference, so others were thinking the same thing. Friday the stock dropped 5%, not because of any fundamental change but because the hot money crowd that bought on Thursday found themselves in a generally down tech market.

I realized I did not really understand what Akamai did. Speed up the Internet for their customers, sure, but how?

Apparently Akamai realized that while the Internet is supposed to function automatically, in reality that functionality is not always very efficiently. Simplifying somewhat, when you enter a URL in your browser, say www.YouTube.com, the browser sends out a request for information from the URL. Out in the internet a "name server" translates the YouTube into a number, the IP (Internet Protocol) number of YouTube, and the first router (more than likely made by Cisco) uses its map of the Internet to either (1) forward the request to another router or (2) if it is connected to YouTube, actually forward the request to the YouTube server farm. There the request is processed and sent back to the originating address, again through at least one but usually many routers.

The existence of many routers means there are usually multiple paths between end points. Some paths have more routers in them than others, and routers produce delays, usually very slight ones. But an overloaded router can be a problem.

Akamai has an array of servers that monitor the state of Internet traffic. They use that information to do two things for their customers. One is that they are able to optimize routes - choose the fastest routes for their customers. The fastest route may shift from second to second or on any other time scales. The other is they allow content to be held near the end points that are frequently requesting it. Thus if a particular YouTube video is being watched by large numbers of people on a given day, instead of going to the YouTube servers every time a request is made, the request can be answered from a cache that is time-wise closer to the end user. Akamai claims to handle 20% of Internet traffic.

Akamai's servers, in addition to monitoring Web traffic, can hold its customers content and server it up in an efficient manner.

This is important to Akamai's customers because there is little point to serving up content if the end consumers have gotten bored and clicked onto something new while waiting for all those routers to get their act in gear.

It is a great company with good ideas. But I have decided not to buy the shares. Why? By my criteria (but obviously not by some other investors) the price of the stock is too high. I think of it in terms of market capitalization, which for AKAM ended today near $8.6 billion. The company is predicting that revenues for 2007 would total $610 to $625 million, with adjusted (non-GAAP) net income around $200 million. Now that is a great model, getting almost 1/3 profit out of your revenues. But the high market cap to sales and market cap to profits ratios are too rich for my portfolio, given other choices available. I have seen too many companies on upward trajectories level off their growth rates to draw a straight line several years out assuming these ratios will remain this high. Three years of continued high growth could prove me wrong.