A Pure Play on Exploding Digital Data Transmission

Cory is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

The number of fixed broadband internet subscribers exploded during 1998-2003, but since then, it has grown at a fairly constant rate of about 50-60 million per year. That lack of acceleration puts internet service providers and hardware manufacturers in the slow growth drawer.

The amount of digital information passing through those lines is still growing exponentially, mainly in the form of streaming video. As a savvy investor, you're probably already thinking about how to make some money from this global trend.

During Google's (NASDAQ: GOOG) latest earnings webcast, Chief Business Officer, Nikesh Arora, mentioned that YouTube now has more than one billion monthly users. Those users are streaming about 150 million hours of video per day, up about 50% from a year ago.

I believe that Google is a fantastic company, but not for investors looking to profit from the explosive growth in digital data transmission. In the first quarter of 2013, Google's own websites -- including YouTube -- contributed $8.64 billion of its $13.97 billion in total revenue. Unfortunately, Google's management doesn't disclose exactly how much of that $8.64 billion originated from YouTube alone.

So, what can you do if you think there are still profits to be made from expanding rates of data transmission, but don't want to get involved with mobile devices, glasses, and driver-less cars? Three words for you... just three words: "content delivery networks."

Since 1998, Cambridge, Massachusetts-based pioneer, Akamai Technologies (NASDAQ: AKAM), has been helping a wide array of customers deliver large amounts of data in a faster and easier manner. Using its proprietary Akamai Intelligent Platform, it identifies its customers' most popular content, then stores it closer to the regions where that content is most often accessed.

When evaluating potential long-term investments, a ‘SWOT’ method works well. A balanced look at Akamai’s Strengths, Weaknesses, Opportunities, and Threats will create a clear picture of the company's prospects going forward.

Strengths

Akamai has no over-sized clients. According to the company's investor relations page, "As of the beginning of 2012, one-third of the Global 500 companies entrust their online business to Akamai." That's an impressive client list. More importantly, in the company's latest quarterly report, no single client accounted for more than 10% of revenue.

The exploding growth in data transmission is more or less reflected in Akamai's revenue growth. Over the past decade, Akamai has reported growing revenue year after year, from $161.26 million in 2003 to $1.37 billion in 2012. 

A quick look at the company's balance sheet shows that the company isn't facing any liquidity issues. Akamai has enough current assets to cover its current liabilities nearly four times over, and is carrying no long-term debt.

Akamai should also benefit from the informed leadership of its co-founder and recently appointed CEO, Tom Leighton. His March 13, 2013 purchase of 30,000 shares raises his stake in the company to over 3.8 million shares.

Insider transactions are another positive sign for the company. In the past three months, there have been 18 insider purchases and only two sales.

Weaknesses

Rather than taking on debt to finance its growth, Akamai steadily diluted shares from 118 million in 2003 to a high of about 191 million in 2010. Since then, the number of outstanding shares have been reduced to about 181.56 million.

Last earnings season, the company missed revenue estimates, and it was crushed. From quarter to quarter, the company's share prices are relatively stable, but whenever Akamai posts a slight miss in its top or bottom lines, the stock gets hammered.

After reporting positive first-quarter 2013 numbers, the gloom was lifted. Given the tendency of Wall Street to overreact, a slight miss could cause you to lose your nerve and exit your position.  It's for this reason that I'm waiting for the next mild disappointment before making a purchase.

Opportunities

I believe that web security is where Akamai has an economic advantage over its smaller competitors. The company has over 100,000 servers in more than 1,000 locations worldwide. Clients experiencing a denial-of-service attack can typically remain functional as Akamai provides the immense volume often necessary to absorb the incoming requests.

Its competitors are going to have a difficult time expanding their network to a size capable of competing with this pioneering giant. Their size and reach creates an economic moat, and that's how I believe the company will continue to maintain profitability going forward.

Threats

As hardware becomes less expensive, larger companies are finding that it is cost effective to provide their own content delivery networks, which is squeezing margins for companies like Akamai. The company and its competitors are coping by also offering their clients other services, like web security.

International telecom service provider Level 3 Communications (NYSE: LVLT) is a Tier 1 Internet provider. Among other services, its content delivery network competes with Akamai. Its Tier 1 positioning might give Level 3 an opportunity to undercut its competition.

Luckily for Akamai, Level 3's balance sheet isn't strong. The company hasn't had a profitable year since 1998, and is heavily in debt.

Final Suggestion

Over the past five years, Akamai's per share earnings have grown at a compound annual rate of about 7.2%. Projecting that rate forward ten years would give you a per share earnings of $2.25 for fiscal 2022. Over the past five years, the company's shares have traded at a multiple between 20 and 60 times earnings. At an average of about 40 times earnings, you can reasonably expect a share price of about $90.40 in 2022.

Akamai's closing price on Friday, April 26 was $33.40. Any shares you pick up at that price and sell ten years from now should realize a gain of about 10.4% compounded annually.

A rate of 10.4% is nothing to sneeze at, but I'm going to wait patiently for another overreaction to the down side before initiating a long position in this promising company.


Cory Renauer owns shares of Google. The Motley Fool recommends Google. The Motley Fool owns shares of Google. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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