Buy The Dip In Akamai Stock?

Akamai (NASDAQ:AKAM) stock tumbled 14% in Friday’s trading following its Q3 earnings report, which largely met expectations but raised concerns with a weaker Q4 guidance. Moreover, the continued decline in the company’s core content delivery network (CDN) business, appears to have compounded investor worries. With the recent sell-off, the stock remains down by about 24% year-to-date. Q3 earnings came in at $1.59 per share on an adjusted basis, while revenue stood at $1 billion up about 4% year-over-year, full-year revenue guidance range was lowered with the new midpoint of guidance coming in at $3.98 billion,  marginally lower than the consensus estimate of about $4 billion. However, we think that the stock looks oversold given the improving performance of the company’s newer security and cloud computing businesses. Here’s a closer look at Akamai’s performance over the last quarter and what lies ahead for the stock.

Akamai’s CDN – or content delivery business which handles the delivery of Internet content and applications – continued to lag, with sales falling 16% year-over-year to $319 million. While Akamai attributed the slowdown to macroeconomic and geopolitical headwinds, the business has been losing traction over the last few years due to mounting competition from hyper-scale cloud providers who are gaining market share with their more flexible offering. Moreover, large customers such as Netflix have also been moving more of their content distribution operations in-house to save costs. The shrinking legacy business and the company’s continued investment in the new business have impacted Akamai’s margins. While Adjusted operating profits were roughly flat compared to last year, the non-GAAP operating margin for the quarter stood at 29%, down 200 basis points versus the same period last year.

However, Akamai’s two other segments fared well.  The security business recorded revenues of $519 million, up 14% from a year ago. Security presents a solid growth opportunity, as more activity moves online and as organizations become more distributed, companies and governments will require highly effective cybersecurity solutions to protect themselves from data theft and potential disruption of operations. Cybersecurity also pairs well with Akamai’s content delivery business, enabling it to cross-sell security software to existing customers. Earlier this year, Akamai combined its various security offerings into the Akamai Guardicore platform, integrating a combination of micro-segmentation, Zero Trust Network Access, multi-factor authentication, DNS firewall, and threat hunting. Akamai is also increasingly focusing on Application Programming Interface or API security.  APIs – which are essentially software interfaces enabling communication between programs – handle crucial data and are attractive targets for attackers. Akamai has been seeing strong demand in this space, aided by its prior acquisition of Neosec while it also closed a deal to buy another API security player Noname Security in June. IDC Research predicts that the API security market will expand at an annual rate of 34% to nearly $1 billion by 2027.

Akamai has also made significant strides in the cloud computing space, expanding its presence following the acquisition of Infrastructure as a Service (IaaS) provider Linode. Although the cloud market is highly competitive, with major players like Amazon Web Services and Google Cloud as rivals, Akamai’s cloud business is growing rapidly. In Q3, cloud sales rose 28% to $167 million. However, investors are concerned that scaling the business may require a significant increase in capital spending.

The decrease in AKAM stock over the last 4-year period has been far from consistent, with annual returns being more volatile than the S&P 500. Returns for the stock were 11% in 2021, -28% in 2022, and 40% in 2023. In contrast, the Trefis High Quality (HQ) Portfolio, with a collection of 30 stocks, is much less volatile. And it has outperformed the S&P 500 each year over the same period.

Why is that? As a group, HQ Portfolio stocks provided better returns with less risk versus the benchmark index; less of a roller-coaster ride as evident in HQ Portfolio performance metrics. Given the current uncertain macroeconomic environment around rate cuts and multiple wars, could AKAM face a similar situation as it did in 2021 and 2022 and underperform the S&P over the next 12 months – or will it see a recovery?

We remain bullish on Akamai stock for a couple of reasons. Akamai stock trades at just about 14x estimated 2024 earnings, which is a relatively reasonable multiple in our view. While the company’s CDN business decline is impacting its overall revenue growth, the narrative on the stock could shift toward the compute and security side of the business, now that they account for roughly 70% of Akamai’s total revenues. In contrast, rival Cloudflare – which is also engaged in content delivery and security – trades at about 100x earnings. Sure, Cloudflare’s growth is considerably higher with revenue on track to grow by about 28% this fiscal year, versus consensus estimates of about 5% growth for Akamai. That said, even Akamai grew its non-CDN businesses at about 17% year-over-year in the most recent quarter. We believe that Akamai stock could be treated to a higher multiple as it continues to execute strongly on its cloud and security strategy. Our $119 price estimate for AKAM stock is 33% ahead of the current market price. See our analysis on Akamai Valuation: Is AKAM Stock Expensive Or Cheap? for more details on what’s driving the company’s valuation and how it compares with peers.

[1] Returns as of 11/9/2024
[2] Cumulative total returns since the end of 2016

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