AKAM - Akamai Technologies: Re-Rating Not Complete

Summary

• Akamai Technologies, Inc. has seen continued growth, albeit accompanied by margin pressure.
• Lower earnings are concerning, although Akamai Technologies shares have come down a bit as well.
• I am still not that enthusiastic about Akamai Technologies, Inc. at 22 times earnings, amidst higher interest rates and some debt being taken on following a dealmaking spree last year.

Late in 2021 I wondered if shares of Akamai Technologies, Inc. ( AKAM ) offered a secured investment, just like its offerings are designed to provide security for its users. At the time an $115 stock, Akamai Technologies shares have gradually come down to current levels around $88, as a pullback of nearly 25% is significant over this time frame of just over a year.

A Quick Recap

Back at the end of 2021, I observed that Akamai has seen a continuation of growth, notably its security segment. That looked quite good, yet was not too convincing in a near-perfect environment, as a high valuation made it hard to to justify initiating a position given the risk-reward proposition.

Akamai plays a key role in today's online world, with its services used to provide a secure digital experience. Being positioned towards growth of the internet and cybersecurity, the company has seen a boom since the pandemic, with growth rates having consolidated around 10%. Akamai's positioning as part of the backbone of the industry allows people to safely shop online, play games, share ideas, manage money, all with its edge delivery platform.

The company grew 2020 sales by 10% to $3.2 billion, with the U.S. and international revenues being pretty equal in terms of size, as the similar balance was seen between the web division and the media and carrier division. The core edge technology group is responsible for about two-thirds of sales, growing at single digit rates complemented by a much more rapidly growing cybersecurity business.

The company posted operating earnings of $658 million, for margins of around 20%, with GAAP earnings of $557 million coming down to $3.37 per share. With 165 million shares starting the pandemic around the $100 mark, valuations were quite high, even as the company operated with a net cash position of $0.6 billion. Adjusted earnings were posted at $5.22 per share, although it excludes for a $1.19 per share stock-based compensation expense, for realistic earnings around $4 per share. The resulting 25 times multiple was a bit rich for a business growing by around 10% per annum.

With the company posting a high single-digit increase in sales so far in 2021, shares rallied to the $116 mark by December 2021, as net cash holdings rose a bit. Pegging realistic earnings around $4.50 per share, the resulting asset valuation at 25 times earnings was quite demanding, as the company commanded an $18 billion valuation at the time.

To further bolster its security portfolio, Akamai announced a $600 million deal to acquire Israel-based Guardicore, adding just $30-$35 million in annual sales, with the deal coming with a hefty price tag. All of this made me quite cautious for all the reasons mentioned above.

Getting More Fairly Valued

Since December 2021, Akamai Technologies, Inc. shares have pulled back 25% to $88 at this moment of writing, with shares up a bit from the lows around $80 per share this summer.

In February 2022, the company posted an 8% increase in full year sales to $3.5 billion, with adjusted earnings up 10% to $5.74 per share. GAAP earnings were up 17% to $3.93 per share, with realistic earnings likely coming in around $4.50 per share if we adjust for stock-based compensation.

A little later that month, Akamai announced the $900 million deal to acquire Linode, an infrastructure-as-a-service platform provider. The deal excludes tax savings with an estimated net present value of 120 million. Given the $100 million revenue contribution, the resulting 8-times sales multiple looks a bit rich, with adjusted earnings accretion seen at five to six cents.

2022 - Softer Than Expected

For the fiscal year 2022, Akamai Technologies, Inc. grew sales by 4% to just over $3.6 billion, as reported growth rates were cut in half by a strong dollar, with constant currency growth being equal to 8%. Dealmaking made that gross cash balances shrunk to $1.43 billion by the end of 2022, as convertible notes rose to $2.29 billion. These notes are a bit tricky to account for, with shares hovering around the conversion price.

With a current share count of 157 million shares trading at $88, the company commands a $13.8 billion equity valuation, or about $15 billion if we account for net debt here. In terms of profitability, 2022 was a tough year with adjusted earnings down from $5.74 per share to $5.37 per share. With stock-based compensation up thirteen cents to $1.35 per share I am cutting my realistic earnings estimate to $4 per share. Trading at $88, the multiple comes in at 22 times earnings, as dealmaking has made that a modest net debt load has been incurred.

The outlook for 2023 is a bit underwhelming, even as the company will see a huge benefit to earnings from an increase in the useful life of its equipment from 5 to 6 years, to the tune of more than $50 million dollars in 2023, adding more than a thirty cent gain to earnings per share.

Adjusted earnings are only seen at $5.40-$5.60 per share, which suggests that outside this accounting change in the useful life of equipment, that earnings are expected to come down a bit again, amidst growth slowing down to low single digits.

Feeling Insecure

The reality is that Akamai Technologies, Inc. shares have been de-risked a bit, with multiples having come down from about 25 times to 22 times, mostly the result of the share price decline, in part offset by slightly lower earnings. The issue is that another year of profit declines is anticipated, as higher interest rates makes the relative appeal of the earnings yield less attractive.

Combined with some debt taken on following deals which still have to play out, and the fact that growth has slowed down meaningfully, it is all of this which makes me very cautious about Akamai Technologies, Inc. So, I am not ready to commit to Akamai Technologies, Inc. stock here yet.

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