Like many other technology stocks lately, Akamai Technologies (NASDAQ: AKAM) has come full circle back to its pre-pandemic level. However, unlike many other tech stocks that experience huge declines, AKAM is actually trading at an inventory valuation value. AKAM is trading at 25 times earnings with a significant amount of cash on the balance sheet to buy back shares. Although the company does not yet pay a dividend, it provides a stable growing business that allows you to benefit from the rebound in technology in the near future. Over the past 10 years, the company has also consistently repurchased shares with cash flow expected to pick up in 2022 and support the stock. The company is growing its edge computing business well, with more than $200 million in annual run rates and adding security capabilities over time.
First quarter results
The company posted 7% year-over-year growth in 2021, but started 2022 well with 9% currency-adjusted growth in the first quarter. The growing parts of the Security and Compute business have both made good progress and now account for over 50% of the business. As these continue to evolve, AKAM can get more credit for these segments and again earn a higher multiple rather than being valued as a “legacy” technology based on the broadcast activity of contents. These parts of the business also have structurally higher gross margins, allowing for increased profitability over the next few years. Over the past 5 years, revenue has grown an average of 8% per year, but EPS has grown 16% as scale advantages increase. In the first quarter of 2022, Legacy Content Delivery revenue was down 4% year-over-year adjusted for currency fluctuations, showing relative stability with high profitability. The company is seeing some slowdown in traffic as OTT streaming and gaming have weakened in recent months. This is to be expected and more of a return to a longer term slow growth trajectory than a fundamental shift. People are getting out of their homes more, but after a perhaps slower summer than in recent years, fall should improve. The company generated $119 in GAAP revenue in the quarter, with a significant headwind from foreign exchange. Companies with a strong international presence like Akamai will experience headwinds this year with a flight to the safety of the US dollar and the volatility of many currencies.
Profits leading to acquisitions
AKAM is using a good part of the cash available on acquisitions to strengthen activity in the IT and security segments. As the company seeks to keep its core delivery revenue stable, it is focusing on growth elsewhere. The company currently has US$1.3 billion in cash, allowing it to continue buying small, high-growth companies to bolster the business. Akamai is also seeing the first returns from its acquisition of Guardicore starting in late 2021. After paying $600 million and expecting $50 million in revenue in 2022, the price paid was 20 times sales. However, using the large cash position to expand its capabilities in the Zero Trust space is essential for AKAM to continue its growth. This will enable AKAM to increase strategic value with customers in critical areas. Being able to stop malware from spreading once it’s in an organization is essential for security. These micro-segmentation capabilities are becoming increasingly important as ransomware and similar attacks increase since 2020. The company has already signed the biggest deal in history since its acquisition with a $10 million deal over 3 years in the first trimester. This security agreement was followed by another interesting agreement in the computing segment.
Linode was recently added in the first quarter of 2022 for 900 million to boost the compute group which includes cutting-edge applications, developer tools and infrastructure as a service. 179,000 people used it in April as many wanted a multi-cloud approach with reduced cost outside of hyperscaler options. Linode will immediately add $100 million to revenue this year with long-term growth potential. Over time, this will add $125 million in tax benefits, resulting in a reason of 7.8 times the sales multiple. It offers developers a powerful platform to build and scale applications where users will be in the cloud and on devices. Major customers have already switched to Linode and have been delighted with its ease of use. AKAM has a good opportunity to cross-sell and increase the growth rate in the future. The plan is to use their current sales team for Linode, which avoids having to incur additional sales expenses to increase this growth in future years. CEO Tom Leighton describes it as follows:
“You can just take your container, your application, and the container and move it to Akamai, and have it all end-to-end, from the cloud core to the edge. You can build your app on Akamai. You can run it on Akamai. You can deliver it on Akamai. You can perform the computation you need at the real edge in thousands of places. And of course we will provide security for you.
The real vision is to be able to offer everything from networking to content delivery to edge cloud solutions.
The stock has held up much better than many of its tech peers, but it has still taken a hit in recent months, down around 20%. At 19x forward earnings at the bottom of its valuation range in recent years. Cash flow continued to increase to $865 million over the past year to support redemptions – up to $103 million in the first quarter. The company said it would be opportunistic to buy back shares, providing support for the stock whenever it falls below its 50-day mark. Anywhere below this level would be a good place to start building a position.
When looking for value in this market, you need to look for strong cash flow generators, growth potential in new segments, and an attractive valuation. Akamai does the trick in all three areas with 2 purchases increasing medium term growth potential as well as very stable revenues. AKAM is mission critical for many clients and the core business will continue to generate cash over the long term and deliver great value to investors.