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Akamai Technologies, Inc. Soars! Should You Chase the Rally?

Pretty much all stocks have been winners lately due to tax reform, but one stock that has been an especially big winner of late is Akamai Technologies, Inc. (NASDAQ:AKAM). Elliott Management’s Paul Singer disclosed a 6.5% active stake in AKAM on Friday, arguing that shares are “significantly undervalued” and that there are numerous “operational and strategic” opportunities the company can pursue to maximize value.

AKAM Stock: Akamai Technologies, Inc. Soars! Should You Chase the Rally?

Source: Shutterstock

That wording implies buyout potential at a healthy premium.

AKAM stock jumped 14% higher on the news. And it’s still heading higher. AKAM stock is now at $67, representing a 16% rally over the past several days.

Should you chase the rally?

Well, it depends. By my numbers, AKAM is more than fully valued as a standalone company without M&A prospects. Thus, the question of should you chase the rally hinges on the likelihood of a buyout at a healthy premium.

AKAM Stock’s Standalone Value

Here’s the thing about AKAM: the company is immersed in secular growth industries like cyber-security and over-the-top entertainment, but you would never guess it by looking at the company’s growth rates.

Revenues grew 7% last year. The quarterly revenue growth rates this year have been 8%, 7%, and 6%. Revenues are expected to grow 6% this year, and 8% next year.

Those aren’t exactly hyper-growth numbers. But like I said, AKAM is immersed in the huge and growing cyber-security and over-the-top entertainment markets.

So what is going on?

The company’s Cloud Security business is growing as expected. Revenues in this segment are consistently growing around 25% to 35% year-over-year each quarter. Cloud Security revenues now account for about a fifth of Akamai’s total revenues.

But the company’s Media business (which is where all the over-the-top tailwinds should be) is struggling. After 11% growth in 2015, revenues in the Media business dropped 10% last year. They fell 9% through the first two quarters of 2017, and dropped 3% last quarter.

Why the decline? The Big Six internet platform companies are “in-sourcing” Akamai technology. These do-it-yourself efforts from the Big Six are really weighing on revenues, and dampening the prospects of future growth.

But the good thing is that while revenue from internet platform companies dropped 34% last year, revenue from everyone else jumped 15% higher. That trend has remain largely true this year. Internet platform revenue growth rates this year have been -29%, -17% and -13%. Revenue growth rates ex internet platform players have been 13%, 10% and 8%.

Plus, everyone is going OTT, and that will create a broad-based growth tailwind for AKAM’s media segment.

Overall, then, this isn’t a big growth company, but it is a stable growth company. Cloud security growth rates will come down due to the law of large numbers, but that slowdown should be offset by a ramp in Media revenues due to a big OTT transition. Net revenue growth should consequently remain in the high single-digit range.

Meanwhile, margins are under pressure, but that is mostly due to weakness in the Media segment. As this segment rebounds with the OTT transition, margins should come back. We are talking a rebound in operating margins from 23% last quarter to the high 20’s rate seen over the past two years.

High-single-digit revenue growth plus healthy margin expansion should drive something like 10%-15% earnings growth over the next several years. Call it 12.5%.

The S&P 500 is trading at 95% premium to its earnings growth potential (20.5x this year’s earnings for 10.5% multi-year earnings growth prospects). AKAM easily deserves a similar premium, implying a fair price-to-earnings multiple of nearly 25x. A 25x multiple on this year’s $2.56 earnings estimate implies a fair value of $64.

Akamai’s Value Considering M&A Prospects

AKAM stock is overvalued without M&A prospects.

But many analysts believe that Akamai is an attractive acquisition target. That is true, given its leadership position in secular growth markets.

The potential takeover price being thrown around is $80. But even though AKAM is an attractive acquisition target, the chances of a deal actually materializing are still rather bleak at this point in time. I wouldn’t call it 50/50. More like 25%.

So lets do some math. There is a 25% chance AKAM stock gets taken out at $80, and a 75% chance it falls back to its standalone fair value ($64).

That implies a fair value of $68.

Bottom Line on AKAM Stock

So should you chase the rally in Akamai?

It depends on how likely you think it is than AKAM stock gets taken out at $80. Right now, I think the market is pricing in just under a 25% of that happening.

As of this writing, Luke Lango did not hold a position in any of the aforementioned securities. 

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