Agonizing over Akamai
There are few business predictions I'd make with cast-iron guarantees, but this one qualifies: The amount of information and content bouncing around the Internet will grow dramatically in the future.
The point of stating the obvious is to imagine businesses that would undoubtedly benefit from a tide so sure to rise in the years ahead. One clear choice in our backyard: Akamai Technologies Inc., the Cambridge company that helps clients route heavy Internet traffic so it doesn't get bottled up.
But Akamai doesn't look like the future beneficiary of a sure thing at this moment, at least judged by its shares. The company's stock has plunged 45 percent since this year's peak, reached in February, and closed yesterday at $32.47. Its 35 percent slump since July 19 has been exceeded by just five other companies in the Standard & Poor's 500 index, a very short list that includes home-loan disaster Countrywide Financial Corp. and a mortgage insurance company.
A stampede of investors anxious to take advantage of Akamai's sudden, deep stock-market discount is not forming anywhere in sight. More brokerage analysts recommend holding Akamai shares than actually going out and buying the stock, by a count of 13 to 11. Analysts and portfolio managers at money management firms are similarly cautious about jumping on Akamai stock.
"The risk-reward has improved considerably, but I don't think it's cheap yet," says analyst Tony Ursillo, of Loomis Sayles & Co. in Boston.
The matter of timing, when to get in or out of an investment, has been especially important for owners of Akamai. This is a stock that went public at $26 per share, hit $327 in two months, sunk to 71 cents in two years, and returned to $56.40 earlier this year.
Looking ahead, analysts and shareholders don't expect anything so dramatic. They see all that growing Internet traffic, for sure, but also complications.
Akamai's first problem was that the stock had gotten too expensive earlier this year, driven to its peak by growth momentum investors. Now those investors worry Akamai's blistering revenue growth rate is slowing and the company's gross profit margin is under pressure.
Akamai's revenue has been growing by more than 50 percent a year, but the company recently suggested a range of 40 to 45 percent for the year, and some investors worry even slower growth lies in the future.
The company's gross profit margins are getting squeezed by two forces: increased price discounting for its services and rising capital expenses required to serve its growing customer demand.
Akamai says discounting reflects a shift in its business mix, favoring more high-volume work managing the movement of video on the Web. Investors worry that more competition in a field Akamai still dominates but no longer owns alone is driving prices lower.
"If margins get too high, your customers and competition are going to do something to bring it back into line," says Chris Ely, managing partner at Nichols Asset Management in Boston.
Meanwhile, anticipating more business growth, Akamai is spending money for more servers, dedicated storage space, and research.
"They're making these investments because they have visibility on where demand is going," says Ursillo. "It's not like they're building and then hoping. However, it's becoming a more capital-intensive industry, so I think the needs are going to run at a higher level than a lot of us expected."
Akamai's growth is slowing below 50 percent a year, and the company has to spend money to make more in the future. Most companies would love to tell that story. But the financial math behind Akamai's stock is changing, and for now investors would rather watch than buy.
