Shares of Akamai Technologies, Inc. (NASDAQ:AKAM) plummeted Wednesday after the company gave a weak second-quarter guide, which clearly disappointed investors.
But I’d like to take the contrarian viewpoint on AKAM stock. I think this sharp selloff creates a compelling buying opportunity.
I am buyer here and lower, all else equal. Here’s why.
AKAM and the Bizarre Selloff
We think the CEO is right in calling this recent selloff “bizarre”. The company beat on Q1 revenue estimates by $4.5 million and per-share earnings estimates by 2 cents, but guided for Q2 revenue of $20 million below estimates and Q2 earnings of 5 cents below estimates. Fair enough. The Q2 guide was weaker than the first-quarter beat, so the stock should reasonably head lower.
But a drop in excess of 16% is a head-scratcher. That is especially true when revenues and earnings are still growing, margins are stable, the multiple isn’t rich, the balance sheet is cash-heavy, cash flows are strongly positive and the long-term growth story looks quite promising.
At the core, investors are worried that a slowdown in spending from the big-six internet platform companies will continue to cause media revenues to fall. That will ultimately weigh on AKAM results as security growth moderates. The company’s earnings growth will look more like low single-digits as opposed to mid-to-high single-digits.
We think that bear stance, though, is needlessly short-term oriented.
AKAM Stock Has Major Catalysts
Firstly, the Media segment has two major catalysts over the next several quarters to years that could hugely boost growth.
The first of those catalysts is the continued shift from Linear TV to Internet TV. The continued strength of Netflix, Inc. (NASDAQ:NFLX), as well as the efforts of other major media companies like Walt Disney Co (NYSE:DIS) to build out over-the-top (or OTT) services, underscore the growing trend of OTT video consumption. OTT video consumption is performance-sensitive, especially when dealing with high-quality and/or live streaming. That catalyzes demand for AKAM’s high-quality products.
The second media-related catalyst is AR/VR, which could yield hugely positive results for the company’s gaming segment. Like the transition from linear TV to internet TV, there is a shift in the gaming world toward AR/VR oriented platforms. Also much like internet TV, AR/VR gaming is highly performance sensitive. That also creates a demand catalyst for AKAM solutions.
Essentially, in the media segment, major product categories are moving toward more performance-sensitive mediums, and that allows AKAM to differentiate itself through quality — to “de-commoditize” the market, which will help grow AKAM’s revenues and margins.
Secondly, while growth may be slowing in the security business, we think the long-term trend is just getting started. As best illustrated by strong results from PayPal Holdings Inc (NASDAQ:PYPL) and Square Inc (NYSE:SQ), mobile shopping adoption is accelerating. I identify this (more people shopping on their phones) as one of the most powerful, secular trends in retail today.
That means retailers are going to significantly build-out their mobile shopping apps, and as these retailers compete to have the best mobile shopping experience, demand for AKAM’s mobile-first solutions will soar.
Lots to Like About Akamai
On the financial side, the company has just under $900 million in net cash on the balance sheet. That is about $5 per diluted share, or just under 10% of the current market cap. Cash flows are great, as the company turned $81 million in net income into operating cash flow of $143 million in the quarter.
Free cash flow was about $50 million in the quarter. Cash gross margins and Ebitda margins are relatively stable, with quarter-to-quarter fluctuations simply being noise. The company is buying back shares (1.1 million this past quarter).
Above all else, the valuation is quite attractive. At 18-times forward earnings, investors aren’t paying much for exposure to certain high-growth segments like AR/VR gaming.
AKAM was overvalued back in early 2017 at $70-plus per share, but AKAM stock is a bargain at $52.
We are buyers here and lower, all else equal.
As of this writing, Luke Lango was long AKAM and SQ.