Monday, June 18, 2007

Akamai Acceleration?

One reason I don't own stock in Akamai Technologies (AKAM) is that the current price assumes very rapid growth; in other words, if you don't like to make assumptions like that, the stock is not cheap. But the company sports some serious business and technological brains. It is the sort of company that two years later, sometimes, makes you feel foolish for not buying it despite the high P/E ratio. Which stood today at 126 (per Nasdaq). In other words, earnings from the past year come to less than 1% of the value of the stock.

Akamai accelerates data exchanges over the Interet (see my Understanding Akamai). Most people who have paid for a broadband Internet connection expect quick downloads; if a page does not download nearly instantaneously, they are on to something else. For a site financed by ad revenue this is bad. For site that serves up such ads, it is very bad. For a site that hopes to sell people something, slow is a disaster.

According to Akamai, of the top 100 Internet retailers, over two-thirds use Akamai to accelerate their web shopping experiences. Akamai has quantified the value of this acceleration: an 11% increase in revenues after Akamai's acceleration technology has been installed. One customer, Motorcycle USA, saw an over 15% improvement in conversion rates (completed sales once a customer has reached a stage of interest). Revenues increased 30%. Best of all their call center volume dropped, allowing them to save money.

Watching my wife try to shop on the Internet is instructive. She browses, but about one-half the time ends up calling in her order rather than finishing it online. She can spend several minutes of employee time finishing an order. Akamai claims customers typically abandon a site after a 4 second wait. Paying Akamai to decrease the wait pays off.

This particular Akamai product is called Dynamic Site Accelerator. "The Akamai solution not only enables retailers to accelerate their dynamic transactions and interactive content, but has also increased browser to buyer conversion rates and reduces infrastructure costs by offloading traffic from customers' Web infrastructure."

For all that, Akamai's revenues were only $239 million in Q1 2007, with net income of $19 million. Even with a continuing ramp 2007, GAAP earnings are unlikely to top $105 million. At today's $7.9 billion in market capitalization, that gives a forward P/E ratio of 75. If the stock price stays the same for about a year and earnings do grow rapidly, today's price may seem reasonable in June 2008.

You might also want to view my summary of the April 25, 2007 analyst conference covering the results from Q1 2007. Management guided to $610 to $620 million in revenues. Management likes to project "normalized earnings," which is a lot higher than GAAP revenue. For instance in Q1 GAAP earnings were $19 million, but "normalized" earnings were $50.7 million. They are guiding to possibly $215 million normalized net income for the year 2007. If the GAAP to normalized ratio holds, GAAP full year net income will be only $70 million. A nice chunk of change, but not one that justifies the stock price.

So we have a rare current-day example of a great technology company that seems to be overvalued by investors. Akamai has great promise, but in my view it requires a couple of years of revenue and profit growth to justify today's stock price.

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