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Morningstar | AKAM Updated Forecasts and Estimates from 01 May 2019

There's no denying that Akamai's business is thriving after the firm followed up recent explosive growth with a quarter that exceeded consensus revenue and profit estimates and led to increased full-year guidance. While we find no faults in the unequivocally good quarter, the underlying data points don't change our belief that Akamai doesn't benefit from a moat, and we are not altering our long-term forecast, which calls for 6% average annual organic revenue growth and 400-500 basis points of operating margin expansion over the next five years. Our $58 fair value estimate won't materially change, leaving the stock overvalued in our view.

As they've been for the last couple years, Akamai's excellent results were almost entirely attributable to its thriving security business. On the flip side, its core content delivery network, or CDN, business is fairly stagnant. If Akamai could simply transition to become a security company, we would reconsider the firm's addressable market and moat sources. However, we don't see that possibility. We believe Akamai's security opportunities are limited to serving its CDN customer base, which will lead to further deceleration in security solutions growth if the CDN business cannot grow. We give management a lot of credit for finding the security opportunity, but long term, we think Akamai is dependent on a CDN business that is ripe for competition from big cloud providers.

On a constant-currency basis, security revenue grew 29% year over year, while CDN and other revenue grew 2%, similar to last year. We project security revenue growth to remain in the mid-to-high 20% range in 2019 before gradually decelerating to midteens growth by 2023. We estimate CDN revenue to remain relatively flat throughout our forecast, including 2019.

Overall constant-currency revenue grew 8%, tracking slightly ahead of our full-year 6% growth estimate, but since the firm lapped an acquisition in the first quarter, we don't expect a major adjustment.

Margins also surprised to the upside during the quarter, with the firm's 29% non-GAAP operating margin closing in on the firm's 30% goal (by 2020) and its adjusted EBITDA margin reaching almost 42%, its highest level in four years. It's likely both metrics were inflated by the firm's adoption of the new ASC 842 accounting standard, which resulted in the firms capitalizing its operating leases, reducing operating expenses but being economically neutral. While margins are likely to remain at slightly higher levels because of the accounting change, they should come down a bit in the second half of the year, when the firm's receipt of royalty payments from Limelight (resulting from a prior legal settlement) ceases and the firm takes on higher costs associated with its new corporate headquarters. We are projecting a non-GAAP operating margin of 28% and adjusted EBITDA margin of 41% in 2019. We may raise them slightly to reflect the accounting change, but there is no change to our economic profitability outlook.

The most surprising and encouraging piece of news we saw in the quarter was that revenue from Internet platform customers (Google, Facebook, Apple, Amazon, Microsoft, and Netflix) grew 6% year over year, the first quarterly growth in almost four years. The flight of these firms from Akamai's platform (dropping from almost $100 million of quarterly revenue to $43 million by the fourth quarter of 2018) is central to our view that Akamai's service is replicable. Those firms largely brought their CDN needs in house, and we think some of them will use that capability to poach Akamai CDN customers. A bottoming out of revenue deceleration from these customers is less important than the indication that they still have a need for Akamai, which to us means they cannot completely replicate the service. We suspect the growth was primarily in international markets, which was the geographic source of Akamai's growth in the quarter and may be where those firms' infrastructure is less developed. We will continue to monitor their revenue contribution to see if the trend continues, but we think it's a matter of time before their infrastructure is sufficiently robust. We don't expect growth from Internet platform customers to continue.