In Akamai's (
) latest earnings report, we observed a pickup in capital
expenditures related to the company building out its servers in
anticipation of more business activity. However, as new
competitors such as AT&T (
), Level 3 Communications (
) and Limelight (
) enter the fray, we worry Akamai will have some competitive margin
compression and, at the same time, continue with significant
capital outlays to stay ahead of competition, resulting in a
double-hit to Akamai cash flows and the
$31 Trefis price estimate for Akamai's stock
If investment stays at current levels rather than decline as we
estimate, this would take 10% off of our current estimates.
Additionally, lower gross margins on its Online Shopping and
Media Delivery from competition could subtract another 7-10%.
Potential Lower Pricing, Higher Spending Combo
We recently wrote that AT&T's Cotendo deal signaled its
intentions to offer services like dynamic site acceleration (DSA)
and application acceleration that Akamai has long dominated.
These services consists of servers and software that help
deliver content like videos and online transaction information
faster to clients like ESPN, Hulu or
Given AT&T's scale in the enterprise market, it possesses
the size to challenge Akamai on a larger scale, as this business
grows and has existing relationships with many of Akamai's
customers. Newer entrants such as Limelight Networks and Level 3
Communications are targeting the booming area of online video.
For Akamai, we expect 2010 capital expenditures to be around 23%
of gross profits, compared to only 15% for 2009. These current
investment levels (as % of gross profits) are notably higher then
historical average witnessed in past five years as evidenced in the
Recent quarters have confirmed a broad based acceleration across
its two main business, Media Content Delivery and Online Shopping
Content Delivery, which combined make up about 45% of the company's
overall value. These two businesses carry high gross margins
- 90% for Online Shopping Content Delivery and 75% for Media
Content Delivery - which will inevitably fall in a more price
While we currently forecast these gross margins to remain
largely stable, a 10 percentage point drop in margin for Shopping
and 5 percentage point drop in Media equate to a 7% lower Trefis
price estimate for Akamai's stock.
While we have not factored this in to our price estimate yet, we
recognize the combined higher spend, lower margin threat a large
competitor like AT&T presents, which could spell problems for
Akamai in the longer term.
You can see
the complete $31.11 Trefis price estimate for
Akamai's stock here.