Akamai (AKAM)

Akamai (AKAM) is a company that provides content delivery network (cdn) services to enable websites to transmit data faster. Akamai was founded by an MIT professor and several of his grad students, went public during the tech bubble, and went from a high of $345 down to a low of 56 cents... quite a roller coaster. This year the stock is up 160%, having settled at $55 today.

Akamai's business performance is certainly been impressive. They have managed to grow revenues over the last several years at a clip of greater than 30%, and the bottom line growth has shown that they have excellent scale of their business model. My foremost concern with AKAM is that the analyst's consensus growth target for the next 5 years is 32%, meaning that Akamai will quadruple current income by the end of 2011. Possible? Maybe. Probable? No.

A worrisome indicator that Akamai might be slipping is Return on Capital (RoIC) numbers, which suggest that the company is losing something in terms of effectiveness - perhaps because Akamai is facing decent competition now, with the potential for much more in the future. Akamai relies on a proprietary algorithm (think Google for data transmission) which will lose protection in 2018, but there is no guarantee that some other person or company won't come along with a better method of execution. I think the operating risks for Akamai are significant, and the economic moat is narrow to non-existent. Few technology companies live up to expectations, not because they aren't good companies, but because there is a certain irrationality surrounding them... which brings us to the valuation of AKAM.

If Akamai grows its bottom line at the analyst-expected rate of 32% per annum, then the implied free cash flow exit multiple is 42x (AKAM currently trades at 90x ttm FCF), using a 12% discount factor and the current price of $55. Akamai needs to substantially exceed those targets in order to have any upside on the valuation, however, so keep in mind what the company is up against. For more conservative valuation purposes, I am going to assume they have some earnings misses, grow the bottom line around 25% per year (still exceptionally high), and justify and end FCF multiple of 30x. That scenario gives AKAM a fair value of $30/share, although leaving a sufficient margin of safety suggests holding off unless AKAM sees the low $20s.
I realize that alot of technology bulls will say that you can't value a firm like Akamai using old-economy DCF models, but following the cash eliminates much of the risk of buying stocks that do nothing but burn money and destroy value. In terms of industry and price, AKAM is clearly outside of my comfort level. I advise anyone considering investing in it to do their due diligence, and consider a research report released by Piper Jaffray, where they say that although the shares likely have some upside, they appear to be fully valued, if not overvalued... and that was written when AKAM was at $49.