LUMN - Akamai Technologies: Improved Growth But Lagging Real Earnings

2023-12-20 04:22:48 ET

Summary

• Akamai Technologies has seen a solid rally in its stock price this year, having risen to highs of $119 per share.
• The company's adjusted earnings guidance has been hiked following strong sales and (adjusted) margins.
• While growth is accelerating, the gap between adjusted earnings and realistic earnings is widening, causing concern for investors.

In February of this year, I believed that the re-rating for Akamai Technologies ( AKAM ) was far from complete. Facing continued growth, although accompanied by some real margin pressure, I was cautious as shares still traded at a premium 22 times earnings multiple, while some debt was taken on following a dealmaking spree in 2021.

Shares have done quite well during 2023, as Akamai has seen stronger growth, but with stock-based compensation adjustments on the rise, realistic earnings growth is not really seen. This makes me very cautious to share this upbeat view.

On Akamai

Akamai plays an important role in today’s online world, with its services being key to offer a secure digital experience. Positioned towards the continued growth of internet and cybersecurity, the company has been a long term secular growth player, serving as kind of the backbone of safe internet with its edge delivery platform.

In the pandemic year 2020, the company grew its sales by 10% to $3.2 billion, with revenues generated roughly equally between the US and international segment. Most of these sales are generated from a solidly growing core edge technology group, complemented by a faster growing cybersecurity business.

In the pandemic year 2020, Akamai posted operating earnings of $658 million on its revenue base, for margins equal to a roughly 20% of sales. GAAP earnings of $557 million worked down to $3.37 per share, with adjusted earnings reported at $5.22 per share. Of the near two dollar discrepancy between both earnings metrics, most was the result of adjustments for stock-based compensation charges, making that realistic earnings came in around $4 per share.

With 165 million shares of Akamai trading at $100 at the time, valuations were demanding given the realistic earnings power, even as the company actually operated with a net cash position of around $600 million.

What Happened?

Since the start of the pandemic, Akamai used its strong net cash position to make some deals, including a $600 million deal for Guardiore, adding a mere $30-$35 million in annual revenues.

2021 revenues rose by 8% to $3.5 billion, with realistic earnings coming in around $4.50 per share, that is if we adjust for stock-based compensation charges. Early in 2022, Akamai announced a $900 million acquisition for Linode, adding another $100 million in revenues to the business.

Dealmaking efforts drove a 4% increase in 2022 sales to $3.6 billion, with secular growth play held back by a strong dollar as dealmaking made that the company took on a near billion net debt load, although mostly comprised out of convertible debt. 2022 was a tougher year with adjusted earnings down by $0.37 per share to $5.37 per share, while stock-based compensation expenses rose to $1.35 per share, reducing realistic earnings to levels around $4 per share.

With shares trading at $88 at the start of the year, the company traded around 22 times earnings, while growth was a bit slower and some net debt was taken on. For 2023 the company guided for adjusted earnings around $5.50 per share, which looks good, but an increase in the useful life of equipment by a year to six years was set to reduce depreciation expenses by $50 million. This provided an artificial boost of $0.30 per share to earnings, which made that adjusted earnings guidance looked a bit underwhelming.

A Huge Rally

Since the start of the year, shares of Akamai have seen a solid rally, having risen from $88 to current highs around $119 per share. As it turned out, the adjusted guidance was cautious, with the guidance hiked following the first quarter earnings report to $5.69-$5.84 per share.

In August, Akamai posted a 4% increase in second quarter sales (with similar growth reported on an adjusted currency basis) as margins came in stronger than expected again, driving a hike in the full year earnings guidance, now seen at $5.87-$5.95 per share.

Later that month, Akamai announced the acquisition of enterprise customer contracts from Stackpath, in a deal set to add $20 million in annual revenues and contribute about four cents to adjusted earnings. The company furthermore issued $1.1 billion in convertible notes (excluding the green shoe option) at a mere 1.125% interest rate, although that the 2029 debt can be converted at $126 per share already, not much above today's share price, thereby a potential source of dilution going forward.

In November, Akamai announced a convincing 9% increase in third quarter sales, with similar growth reported again in constant currency terms, showing a growth acceleration in a tougher macro environment. This growth and strong operating leverage made that adjusted earnings so far are up fifty-one cents to $4.51 per share, warranting an update in the full year earnings outlook to a midpoint of $6.10 per share. Troublesome in this outlook is that stock-based compensation seems to trend closer to $2 per share here, which makes that adjusted earnings are rising, but the same cannot be said for realistic earnings here.

Net debt is reported close to $1.4 billion here, entirely the result of convertible debt, a number which still trails adjusted EBITDA here. The fact that debt is comprised out of low yield convertible debt makes that the company actually receives some net interest income here, despite operating with a net debt load.

Soon after the third quarter results release, Akamai announced another acquisition as it has acquired certain content delivery customer contracts from Lumen Technologies ( LUMN ), in a deal adding $40-$50 million in revenues, set to boost adjusted earnings by ten cents.

And Now?

By now, the 155 million shares of Akamai command an $18.5 billion equity valuation, or about $20 billion enterprise valuation if we factor in net debt. With revenues seen close to $3.8 billion here, valuations have expanded to over 5 times sales. While the earnings multiple looks fair based on adjusted earnings, it is the gap between realistic earnings and adjusted earnings which is rising and discomforting. Based on realistic earnings of around $4 per share, multiples have risen to about 30 times earnings.

Promising is that growth is accelerating again, but for shares to be supported by the growth, we really ought to see growth in realistic earnings as well, something which is lagging in my view.

While the long term strong growth of Akamai has somewhat lowered in recent years, a 9% growth number for the third quarter looks solid, seen again in the fourth quarter (albeit a bit lower). The company benefits from the continued growth of the internet, but its delivery business is actually down. Real growth has to come from a further transition towards the security solutions, as the number of internet attacks keeps rising, as well as growth in the compute business, both emerging segments which gradually drive a transformation of the business.

All in all, I am pleased to see growth having improved a bit, but the worsening quality of the adjusted earnings make me cautious, as I feel no need to get involved here, with investors trusting the adjusted numbers apparently a bit too much here.

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