Akamai’s Stock Soars Again

By Hal Plotkin Silicon Valley Correspondent

Jan 30, 2001 01:11 PM

If you are an arms merchant, you had better be prepared for the next war.

That pretty much sums up the challenges facing leading Internet infrastructure providers such as Akamai Technologies Inc. {AKAM}.

Akamai is one of a handful of Internet firms that includes Digital Island Inc. {ISLD}, Exodus Communications Inc. {EXDS} and Inktomi Corp. {INKT} that have rapidly built recognizable brand names as so-called Internet arms merchants — the specialists who stock the technical arsenal that corporations use to build online businesses.

A year or so ago, when investors were getting nervous about the upstart companies that were laying ambitious e-business plans (using all that hot initial public offering money), analysts identified arms merchants such as Akamai as among the smartest Internet stock plays. The best of these companies were selling their wares to the top corporations in the United States and abroad, so they were viewed as a relatively safe bet, even if demand from online retailers and other Internet ventures disappeared.

Today, analysts are divided on the arms merchants. Internet-infrastructure stocks were battered along with other Net-related issues last year. And, given how the Web is evolving, many of the companies that looked so promising a year ago now may not have the right technology for what the customers will want to do on the Net going forward.

Internet infrastructure boosters, in turn, counter that these firms will do well in a slowing economy because major corporations seek to cut costs by outsourcing more of their information-technology needs. Growth driven by cost-cutting major clients, they say, will more than make up for slackening demand from harder-hit parts of the economy, most notably dot-coms.

Evidence from Akamai’s balance sheet does offer some support for that view. While the company terminated relationships with 50 mostly dot-com customers during the
Most-recent quarter, for example, the company also added a total of 220 new customers over the same period, which is what led to the slightly better-than-expected revenue number. The average revenue per customer per month also grew to $8,350 from $8,000 in the previous quarter, another indication that Akamai may be successfully weathering the tech spending slowdown.

Nonetheless, several analysts warned recently that there may be continued erosion in the valuations of leading business-to-business, or B2B, players such as Akamai at least until the contours of the next online battles are more clear. Chart

Akamai 5-day stock performance Chart
Akamai 1-day stock performance

Akamai’s stock got a nice lift on Monday, after Microsoft Corp. {MSFT} announced it had retained the company to build a redundant network of specialized servers to protect the software giant from continued attacks by computer vandals, also known as hackers. Microsoft’s corporate network was offline for much of last week after the company experienced its worst such attack ever.

Akamai has more than 8,000 computer servers installed around the globe that store and serve requested data to Internet users. That speeds up delivery of Web content by eliminating the bottleneck of trying to deal with all customers from a single location. Akamai’s customer list includes many high-traffic Web businesses that don’t want to manage their own dispersed server networks.

Despite Akamai’s fast-moving bandwagon, however, some analysts warn that the stock could still be heading for the ditch. Some, but not most, mind you. But it is worth noting that analysts are now divided on a leading arms merchant stock they once universally favored.

Last week, Akamai reported results for its fourth quarter that were slightly better than analyst expectations. Losses for the quarter came in at 61 cents a share, 7 cents less per share than the consensus estimate compiled by First Call Corp.

Overall the company, which has about $387 million left in the bank, lost $182.2 million in 2000 and isn’t expected to become profitable until the third quarter of 2002, according to the company’s current projections.

Reflecting the growing division on the stock. two securities firms, Lazard Freres & Co. and Robert W. Baird & Co., downgraded Akamai after the earnings announcement while another, Merrill Lynch, upgraded the stock on the very same news.

Merrill Lynch’s analyst, Thomas Watts, raised Akamai’s stock to “buy” from “accumulate,” citing what he called the company’s “widening competitive lead.”

Watts currently has a $54 12-to-18 month price target on the stock, which is based on 17 times his estimated revenue in 2002.

“Akamai has a lot of advantages,” agrees Melanie Posey, an analyst at International Data Corp. “They have the customer base, and there are lots of costs involved if those customers want to switch. It leaves less room for other competitors.”

Watts estimates that Akamai now controls about 80% of the market for static content distribution, which refers to the delivery to end users of non-personalized Web pages that are sent to all Web surfers with exactly the same content.

But other analysts say that dynamic online content, which can be personalized for individual end users, is likely to grow in importance in the future. The most-obvious example is stock quotes, which are only accurate when very timely. But there are other forms of dynamic content that will become increasingly important, such as menus of products and services that are designed specifically for individual end users based on prior contacts with those customers.

Akamai officials say they will be prepared to compete in the dynamic content market, as well, but the jury is still out on whether Akamai’s current server network will prove up to that task.

Some analysts suggest it won’t be easy and that to compete Akamai will soon face the need to build costly new, or at least supplemental, dynamic server product offerings in the face of increasingly stiff competition from other firms that aren’t weighed down by any pre-existing legacy technologies.

“There will be a number of companies that will be introducing new dynamic content delivery services, and that will be a new challenge for Akamai,” predicts Sujata Ramnarayan, an analyst at Gartner, based in San Jose, Calif.

Ramnarayan advises companies considering the purchase of such services. She says she is sworn to secrecy about the identity of Akamai’s advancing competitors. But she adds that their names will “definitely be known by the end of this year.”

The uncertainty over Akamai’s future and, in particular, worries about the stock’s valuation, led to the recent analyst downgrades.

“If you want to buy the stock, we believe you are essentially buying a call option on Akamai’s future efforts,” says Luke Fichthorn, an analyst at Lazard Freres & Co. “Our discomfort is that we feel the near term numbers are achievable but aggressive, and we have no idea how to value that call.”

Late last week Fichthorn lowered his rating on the stock to “outperform” from “buy,” which doesn’t sound too bad. But he also added that the stock’s current valuation leaves “very little room for error.”

Likewise, Robert W. Baird analysts Dan Renouard and Will Slaughter also cited worries over Akamai’s future as the reasons they took the company’s stock down to “market perform with speculative risk” from “market outperform.”

“We believe more visibility in strong growth beyond 2001 will be necessary to get more aggressive on the stock,” they wrote.

“Right now everyone is positioning themselves against Akamai,” adds Joel Yaffe, an analyst at the Giga Information Group in Boston. “But all those other offerings are still a few years away in terms of having any significant impact.”

That puts Akamai in a strong position over the short term, Yaffe says. But beyond that, he says the terrain becomes far less certain. For Akamai investors, the different time frames matter because the company expects to be nearing profitability just as the new competing technologies are coming fully online.

“There are always going to be disruptive technologies,” Yaffe says. “I think Akamai is the company to watch. But the truth is it’s very difficult, probably impossible, to say what the Internet will look like five years from now.”

The only thing that is certain, the analysts agree, is that Internet arms merchants will have to be selling the most-modern weapons to survive the next war.

Right now, though, many informed industry observers are unwilling to wager on exactly what those weapons will be.

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