EUR 850.00 For Business Accounts Only

Morningstar | Security Solutions Highlight Another Outstanding Quarter for Akamai, but the Stock Is Pricing it in

Akamai reported a superb fourth quarter, exceeding already inflated expectations. Security solutions continues to be the standout, as a second consecutive quarter of nearly 40% year-over-year sales growth resulted in 35% growth for the year--an acceleration from last year's 32% (although acquisitions in each of the last few years makes comparisons imprecise). More impressively, the growth is coming on a security business that now has a $750 million annual run rate and is providing a quarter of Akamai's total revenue. However, while this quarter's security revenue was a bit higher than we projected, we are already modeling average annual security sales growth of over 20% through 2022, and growth in the core content delivery network, or CDN, business, remains modest. We think this is the best of times for Akamai, and while it currently may offer a superior product, we think a lack of a moat will allow competitors to catch up. We will raise our $55 fair value estimate by about $3 to account for the time value of money, a reduced share count (the company bought another $124 million worth of shares in the quarter, bringing 2018's total to $750 million), and other minor adjustments, but we don't see the stock as compelling at current levels.

Akamai's CDN business returned to year-over-year revenue growth after being down last quarter and grew 3% for the year. However, we don't expect CDN growth in 2019, as we think it benefited in 2018 from events such as the Olympics, World Cup, and U.S. elections. While some of those catalysts will return in 2020, we think the CDN business is challenged long term as cloud providers increasingly provide competition. Internet platform customers already began serving their own CDN needs, as evidenced by another year of double-digit revenue contraction from that group. Some are now also offering their CDN services to customers, and we think much of Akamai's edge, which is based on its wide footprint, will erode as those companies scale.

In our view, management's shrewd decision to get into the security solutions business is behind the company's recent success, as it provides a valuable add-on product for customers. While we believe there is a runway for a few more years of high growth, we are not convinced the company has a sustainable long-term advantage. Like we are seeing with the low-growth CDN business, if competitors can ultimately offer a similar product, we think Akamai will find a tougher path to growth. We think in the long term, Akamai will have to make price concessions to grow its customer base and have as much opportunity for security solution sales.

As for the near term, things continue to look good, despite the lack of media event catalysts in 2019. Akamai guided to 5%-6% constant currency revenue growth in 2019 (after 9% growth in 2018) and 41% adjusted EBITDA margins, similar to the fourth-quarter's margin, a full-year level the company has not reached in several years. Management also said the company remains on track to reach 30% non-GAAP operating margins by 2020, which would be a nearly four percentage point expansion from 2018. We also expect the firm will continue generating lots of cash, which we expect it will use for further acquisitions or additional share repurchases, both of which have benefited shareholders in recent years.