(NAS:AKAM) Akamai: Transition to Edge Computing and Security

Neutral rating on Akamai (NAS:AKAM) this month. Through extensive research, analyses, and speaking with IR, our initial hypothesis for a “buy” rating did not materialize. Our principle: if we don’t add it to our portfolio, no “buy” rating. Learn more about why we publish neutrals here

Thesis

We were initially excited to research Akamai due to its strong positioning at the nexus of several, tech-driven trends we have been studying: edge computing, cybersecurity, cloud services, IoT/5G, and AI. Over the years, Akamai has transitioned from a leading content delivery provider (“CDN”) to an integrated player offering content delivery, advanced cybersecurity, and edge compute services. While Akamai’s strategic moves and broad technological reach make it intriguing, we find the company’s reliance on heavy capital expenditures and acquisitions make it difficult to determine whether its growth strategy will be meaningfully value-enhancing.

Company Background

Akamai 1.0 – Short History

Akamai Technologies was founded in 1998 by Dr. Tom Leighton (current CEO), a professor of applied mathematics at MIT, and his PhD student, Danny Lewin (died tragically on 9/11). The company emerged from pioneering research aimed at solving one of the biggest issues of the early internet: network congestion. As the internet grew rapidly, existing infrastructure struggled with heavy traffic, slowing websites and creating bottlenecks that traditional servers couldn’t handle. Content delivery was centralized, which limited scaling options and frustrated users with slow page loads.

Leighton and Lewin realized the solution lay in creating a distributed network of servers positioned closer to end users. This approach would improve reliability and speed by serving content locally rather than from a single origin server. They developed algorithms to dynamically route traffic across a global network, creating one of the first and most effective Content Delivery Networks (CDNs). This innovation allowed Akamai to cache and deliver static content, like images and videos, close to where it was consumed, dramatically reducing latency and improving internet performance. Akamai’s early breakthroughs laid the foundation for modern internet infrastructure, helping to scale the web “to infinity” with sophisticated algorithms. Over time, Akamai evolved from a pure CDN provider to a leader in dynamic content delivery, enterprise-grade security, and, more recently, edge computing.

Akamai 1.5 – Cloudflare Disruption

In 2010, competitor Cloudflare disrupted the CDN market by bundling content delivery with robust security in a low-cost, scalable package. Cloudflare’s “Secure CDN” concept gained traction, appealing to businesses as online threats like DDoS attacks (when many devices flood a website with traffic, causing it to slow down or crash) grew more common. Rather than relying solely on main server defenses, customers saw the advantage of meeting threats “at the edge” with security integrated directly into the CDN.

Cloudflare’s success incentivized Akamai to expand its security offerings. Over the years, Akamai made strategic acquisitions, such as Prolexic (DDoS protection) and Janrain (identity management), bolstering its security suite. Akamai’s security services now include high-end solutions tailored for large enterprises in sectors like finance, media, and e-commerce. Additionally, since Akamai’s security solutions could be layered onto its existing CDN infrastructure, expanding into security required minimal new infrastructure—a distinct advantage in scaling its services.

Akamai 2.0 – Hyperscaler Competition

In recent years, hyperscalers like AWS, Google Cloud, and Azure entered the CDN market by bundling cloud, CDN, security, and compute into comprehensive, one-stop solutions. Their integrated approach attracted customers who appreciated the ease of managing everything in a single ecosystem, while hyperscalers benefited from greater customer lock-in. This all-inclusive strategy began to erode Akamai’s market share, as many companies adopted a multi-CDN framework or shifted entirely to hyperscalers’ platforms. Larger companies, like TikTok or Netflix, even opted to build their own CDNs, further challenging traditional CDN providers.

This competitive environment pushed Akamai to make a significant foray into compute, particularly focusing on compute at the edge. Unlike security, however, expanding into compute requires new infrastructure, with substantial capital investments in co-location facilities and high-capacity data centers.

Competitive Advantages

Largest Global Edge Network

Akamai operates the most extensive network of edge servers, with over 365,000 servers distributed across 130 countries, making it the largest and most geographically distributed CDN provider in the world. This vast infrastructure enables Akamai to deliver content and applications exceptionally close to end users, which is vital for minimizing latency and ensuring high performance, particularly in regions that might not be as well-served by hyperscalers’ data centers. With over two decades of experience in fine-tuning this edge network, Akamai possesses deep expertise in optimizing content delivery across diverse geographies, an invaluable asset for content providers managing latency-sensitive workloads. The scale and reach of Akamai’s network present significant challenges for competitors, including hyperscalers, to replicate.

Blue-Chip Client Base

Unlike hyperscalers, which often provide standardized, bundled solutions, Akamai’s approach involves close collaboration with customers to deliver customized, performance-driven solutions tailored to their specific needs. This personalized support translates into higher performance and alignment with customer goals, particularly for complex or mission-critical operations.

Akamai is well-regarded for its robust customer support and engagement, especially in high-stakes industries like media, finance, and e-commerce. Clients who require dependable, hands-on support often prefer Akamai over competitors. This dedication has fostered long-standing relationships with a blue-chip client base that includes Adobe, Disney, Alibaba, FedEx, Epic Games, NBC, Paramount Global, Spotify, Ubisoft, and more.

Opportunities

Upselling Existing Customers

Akamai has a significant opportunity to expand its services within its existing blue chip customer base. Continued focus on broadening offerings, such as edge compute and advanced security features, could deepen customer reliance and boost revenue from existing relationships.

Growth in Security Services

Akamai’s transition to becoming a significant player in the cybersecurity space presents a compelling growth avenue. The company’s cybersecurity offerings, which include web application firewalls (WAFs), DDoS protection, and bot management, have shown considerable growth. This continued expansion could solidify Akamai’s reputation as more of a cybersecurity provider than solely a CDN company which could fetch a higher market multiple.

Edge Computing Potential

Akamai’s extensive, globally distributed network positions it uniquely to capitalize on the growth of edge computing. The proliferation of IoT devices and AI presents significant demand for edge computing to process data closer to the source. If Akamai can effectively build out a network of edge data centers and enhance its edge compute capabilities, it stands to capture significant market share.

GPUs?

Akamai’s choice not to invest in GPUs for its edge data centers reflects a strategic focus on efficiency and targeted ROI. While GPUs are often essential for high-level AI compute, Akamai has determined that CPUs can adequately handle most edge compute needs, including lower-level AI processing.

Headwinds

Challenges in the CDN Business

Akamai’s traditional CDN business faces significant challenges due to changing market dynamics driven by hyperscalers. While global internet traffic continues to grow, intense pricing pressure has caused Akamai’s CDN revenues to decline. Hyperscalers have popularized flexible, pay-as-you-go pricing models that appeal to customers and make it easier for them to switch providers. Akamai’s CDN business segment is structurally challenged and will likely show anemic growth at best.

Rising Costs from Compute Expansion

Akamai’s expansion into compute has brought with it increased operational costs, acquisitions and capital investments (see below). Co-location expenses and infrastructure build-out have seen rapid escalation. These investments have driven up capital expenditures and related depreciation. The recent change in server amortization from five to six years, as highlighted in Akamai’s 10-K (below), suggests an accounting effort to manage these increased costs. Future acquisitions to support compute expansion add another layer of financial uncertainty, making it difficult to assess whether these investments will ultimately be value-accretive.

From Akamai’s 2023 10-K: In recent years, we have invested in our network as traffic levels have increased and as part of building out our compute infrastructure, which increased our capital expenditures and resulting depreciation expense…the useful lives of our servers have been extended from five to six years, effective January 1, 2023, which has offset increased depreciation expense from our network expansion and the build-out of our compute infrastructure.

Dynamism of Cybersecurity Industry

The cybersecurity sector is fast-moving and marked by constant evolution in threat types and technology. Industry leaders, such as Palo Alto Networks under CEO Nikesh Arora, have demonstrated that staying ahead requires a consistent acquisition strategy to integrate new capabilities. This “acquisition treadmill” is a reality in the cybersecurity space, where smaller, innovative players frequently emerge to tackle evolving threats. While Akamai has made substantial strides in expanding its cybersecurity offerings, the need for continual investment in acquisitions presents forecasting difficulties.

Conclusion

Akamai has the potential to develop a next-generation edge computing network that could outcompete hyperscalers at the edge, particularly in latency-sensitive industries. However, the substantial capital expenditures and the strategic complexity involved make this a high-risk endeavor. We would need clearer evidence of successful scaling in its compute initiatives before considering a position.

There remain key unanswered questions: Has the CDN business stabilized enough to ensure steady growth? Will Akamai’s compute services scale effectively and contribute meaningful value? What will be the cadence and financial impact of future acquisitions to support cybersecurity and compute? Despite thorough analysis, we find it challenging to gain conviction around these aspects of Akamai’s future.

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Past performance is not necessarily indicative of future results. All investments carry significant risk, and it’s important to note that we are not in the business of providing investment advice. All investment decisions of an individual remain the specific responsibility of that individual. There is no guarantee that our research, analysis, and forward-looking price targets will result in profits or that they will not result in a full loss or losses. All investors are advised to fully understand all risks associated with any kind of investing they choose to do.