churns up and down, one stock is making a great upward move. And
the rumor mill gets all the credit.
Trading desks are abuzz with anticipation that
or one of their rivals will soon make a bid for
Akamai Technologies (Nasdaq:
. That's fueled a 25% gain in just 10 days. By my math, this stock
has another 25% to 40% upside, even if no deal ever actually takes
place. The reasons that big tech firms may be lining up to join
forces are the same ones that should make this an appealing
investment for you. Simply put, Akamai is in the midst of a
temporary slowdown before a resumption of growth. And boy it is
I most recently took a look at Akamai in early August after its
stock slid to just $22. [
Read the article here
] The stock slumped even further after that -- into the upper teens
-- before a recent rebound back to $23.
As I discussed two months ago, this is really two businesses. The
first simply focuses on web servers that sit right in the closets
of major Internet access providers around the world, providing
low-margin services such as video streaming. It's a growing
business in terms of
, but price wars
that year-over-year revenue comparisons are flat.
The other part is where companies like IBM and Verizon are likely
focusing -- value-added services (VAS). To stay above the
commodity-end of the content delivery market, Akamai continues to
roll out a broad suite of services, focused on security, traffic
measurement, application performance, ad delivery and cloud
Akamai's comprehensive suite of offerings is helping the company
land new clients at a rapid clip. It brought in 147 new customers
in the second quarter, well above the 50 to 100 added in most
quarters. And fully half of these new customers signed up for at
least one VAS, according to the company. In the past, Akamai would
have had to lure customers in with its low-margin web traffic
delivery service and upsell the VAS later on.
Make no mistake, companies such as Verizon and IBM appreciate that
Akamai carries 20% of all global web traffic that is run on content
delivery service (CDN) platforms. But what they'd really want is a
piece of those higher-margin VASs. They've no doubt noted just how
profitable these services are. "AKAM generated $111 million in cash
in Q2 equating to 40% of sales," note analysts at D.D. Davidson.
Few companies can boast of 40% operating margins.
Despite the cash-sapping effect of ongoing stock buybacks, Akamai
continues to build its cash levels -- to a recent $1.28 billion
(roughly $6.70 a share). And management appears committed to
putting much of this cash back into the business to boost growth.
For example, Akamai is now making a big push into international
markets such as India, Brazil, Singapore, Taiwan, Japan and Hong
Major tech firms are possibly circling around Akamai for a much
more prosaic reason. The company already has deep ties with many of
the leading website operators. Whether you looked at fantasy
football scores on sportsline.com, bought a stock on
, streamed songs on
iTunes or upgraded your computer's McAfee security software, you're
actually dealing with an Akamai server.
Right now, investors are wondering why the company's
appears to be losing steam. Sales are expected to grow just 12%
this year to $1.14 billion, and
earnings per share (
should simply be flat compared with last year, at about $1.45.
Chalk it up to "macro-economic headwinds that are dampening
Internet traffic growth and causing a slight stall in enterprise
adoption of the company's value-added services, analysts at
Dougherty & Co say. They noted a similar slowdown in 2008/2009,
but state that the 147 new customers added in the second quarter
are a harbinger of future business activity. "Recent partnerships
Riverbed Technology (Nasdaq:
among others, also creates a foundation for re-acceleration of
growth in 2012," they conclude.
Dougherty, which carries a $36
on the stock, is more optimistic than others. Indeed, the consensus
for sales to grow just 11% in 2012 to $1.27 billion, while
is likely to grow at a similar pace to $1.62. Many analysts have
concluded the recent slowdown in growth is here to stay and the
company will be hard-pressed to grow faster. Then again, that's
what the pack concluded after seeing a few weak quarters in 2008
and early 2009. This
view proved short-sighted: the stock eventually rose from around
$15 in late 2008 to more than $50 in late 2010.
Risks to Consider:
Circle your calendar for Oct. 26. That's when Akamai is set to
. Recent earnings releases have proven disastrous for the stock: it
has fallen at least 12% in the subsequent three days after the
release on four of the last five occasions. With
back closer to multi-year lows, and quarterly expectations fairly
restrained, the chances of another post-quarter selloff are much
less likely. Still, gains from the recent M&A chatter could
evaporate if a deal hasn't materialized by then and investors see
that Akamai's 2011 results remain a bit pressured.
Action to Take -->
rumors often fail to materialize, so you need to assess a stock
simply on its
. On that basis, shares of Akamai appear too cheap, suffering from
near-term headwinds, and they fail to reflect the long-term
opportunity. If a buyer emerged, then that would simply be icing on
With shares back down at depressed levels, strategic buyers such as
Verizon and IBM may be looking to pounce before the stock makes a
meaningful rebound. On a fundamental basis, it's not clear shares
deserve back to that late 2010 peak of $50, but a move to the $30
to $35 range, representing 25% to 40% gains from current levels,
looks to be in the cards -- with or without a strategic buyer.
-- David Sterman
Disclosure: Neither David Sterman nor StreetAuthority, LLC hold
positions in any securities mentioned in this article.
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