Akamai: Doomed To Commidification

Akamai (AKAM) was an exception in my portfolio. I typically avoid high P/E high market cap companies, but Akamai had a unique and dominant position in the marketplace that I felt people overlooked. But I’ve synthetically hedged out Akamai holdings since September 22.

Brightcove, a company I have written about, released their video content distribution platform today. It seemed necessary to footnote what I have written before and summarize why I’ve closed the door on Akamai.

First and foremost: Everyone is talking about Akamai and how great they are (this is a great example, and is what catalyzed me to action). I rarely read articles or speak with anyone who has anything bad to say about Akamai. This indicates the market has built in perfect expectations to the price.

Of greater concern is whether Akamai is a high margin service provider, or a low margin hosting service.

Today, Akamai exists to outsource hosting for companies using their large, distributed datacenter. Whether it is Salesforce.com, NBC, Apple iTunes, etc. - Akamai sells a distributed hosting infrastructure that ultimately is application agnostic.

Building and operating large data centers is a depreciating barrier to entry. Google (GOOG) has them. Yahoo (YHOO) has them. Microsoft (MSFT) is building them. My blog is hosted on one. They are not the unique resource they used to be. Therefore, Akamai’s hardware infrastructure is no longer a unique advantage.

They do have a compelling advantage on the sales side, with a large direct salesforce and great connections into the big media companies. This advantage is eroding as well. The issue is that Akamai offers nothing but hosting. Companies like Microsoft, Google, and Yahoo can add value beyond hosting. These companies all have the infrastructure to not just host content, but also pair it with the appropriate advertising to extract revenue.

From 'Stay Tuned for an Akamai-Google Clash':

Our assumption appears to be breaking down, as Google deftly repositions itself a more of a mediator of video content rather than an author/owner. The WSJ article captures the leading edge of this trend very well. Google appears to be convincing major networks like CBS to allow them to host and monetize high value content. This is very negative for Akamai.

This was before Google bought YouTube. Google bought YouTube because they wanted to monetize the video content. Akamai provides an agnostic solution that requires the content owners to monetize the content. Extracting value from content is inherently a higher margin business than hosting it on a server.

I believe that Google, Yahoo, Microsoft can better pair content and advertising for each individual viewer. NBC, CBS, ABC, etc. evolved in a world (broadcast TV) where 50mm people all view the same content and advertising. It is hard to imagine they will evolve better advertising systems than the ones already evolving within the search behemoths.

The cost of hosting quality content that can generate revenue will be zero. Google, Yahoo, Microsoft, and others will line up for the chance to cache content for free in order to pair advertising with it (extracting a success based fee). Akamai has no means and has shown no interest beyond operating a very sophisticated hosting company (see 'Brightcove vs. Akamai' from Feb ‘06). This business model does not deserve a triple digit P/E.

Hosting is a commodity. Akamai’s service is no different. The market will eventually price this in; next week, next month, or next year. I don’t want to be a stockholder when it does.

I can calculate the movement of the stars, but not the madness of men. - Isaac Newton

AKAM 1-yr chart:

Comments

[Rajeev Gupta]

I agree that the AKAM is high P/E, but you are absolutely wrong on Akamai's business/revenue model. AKAM is NOT a hosting company and it doesn't compete for hosting business with Google, Yahoo or MSFT. Akamai accelerates the web - which is different from hosting. Hosting is actually a natural bi-product of what Akamai does... but it's revenue comes from the traffic.

So ... do I think more people will be browsing internet tomorrow? Yes.
So ... do I think more folks will be downloading movies and songs from Apple? Yes.
So ... do I think more ISVs will be downloading Vista? Yes.
So ... do I think more developers will be downloading Solaris? Yes.
So ... do I think more people will have handsets tomorrow? Yes.
So ... do I think more people will have data access on handsets? You bet, Yes.
So ... do I think more people will watch Football, Baseball and Cricket on Internet? Yes.
Even dishnet picks the stream that is akamaized by akamai!!

All of this generates more traffic and direct revenue for Akamai. Hosting providers don't make money for higher traffic!! Akamai does. Since akamai is more of a monopoly, one can argue that 2 out of 3 bits that flows through the internet generates money for akamai.

[Peter Bishop]

Interesting article Andrew.

I would argue that strong continued revenue growth for AKAM need not be predicated by the firms introduction of an ad-matching product. They should not aim to try to compete directly with the content providers and matching services provided by Google, Yahoo!, Microsoft and the like. In fact, their agnostic approach actually offers them an advantage in the form of virtual application transparency.

In the Journal this morning, there is an article discussing the difficulties that GMail has had in matching advertising content to text-based emails. Similar issues have emerged in the Microsoft Live Mail Desktop. This problem becomes exponentially more difficult to address when dealing with video and other non-textual media. While the minor snafus of presenting advertisements for flower shops when mis-interpreting the proper name "Lily" in an email may slide right off of a consumer, the producers of video content may not take so kindly to it. The solution to this issue will not be an inexpensive one, and not at all in line with Akamai's core business.

Akamai's core is rooted in the delivery of content and as increasingly complex content (both consumer and corporate) finds it way to the edges of the network, the traditional methods of adding bandwidth and processing capacity will just no longer cut it. The hosting of high quality data and content is the easy part. <b>It's the effective and timely delivery of content that creates value</b> and where Akamai differentiates themselves from commodity hosting solutions. The companies tight integration of advanced compression algorithms and routing capabilities provide a solution that can't be matched by simply building massive data centers.

[MichaelComeau]

Huh? MSFT and YHOO are AKAM customers, not competitors!

[schmitt]

They are today. What about tomorrow?