Akamai Technologies, Inc. (NASDAQ:AKAM) is having an exciting 2018. The company has been targeted by activist investors, which could lead to a big move in AKAM stock at any point. On top of that, the company’s strong earnings report in February, combined with layoffs, filled Wall Street with cheer.
Akamai Technologies stock is still riding high heading into earnings at the end of the month. But will it stay there? On the positive side, its cloud security business is taking off. And an upcoming change in privacy laws should create more business for this division. On the downside, though, the stock is fairly expensive, and the business hasn’t performed all that well in recent years.
Three AKAM Stock Cons
Earnings Have Been Flat to Down: Akamai’s earnings per share peaked at $1.84 in 2014. Earnings were essentially flat in 2015 and 2016 before seeing a decline last year.
This is problematic since Akamai managed to grow revenues from under $2 billion up to $2.5 billion over that period. Unfortunately, the company’s SG&A budget grew almost 50% over the same period, and its cost of goods sold also surged, resulting in no increase in operating income.
That’s not a healthy trend. Falling profit margins tend to put a lid on stock prices. Although, the recently announced layoffs may make a dent in this trend going forward.
Big Customers Cutting Back: Akamai has traditionally relied on the large tech companies for a sizable portion of its revenues. Six customers, including the likes of Netflix, Inc. (NASDAQ:NFLX) and Facebook, Inc. (NASDAQ:FB), are pulling dollars away from Akamai. These firms are, instead, building their own capability to replace Akamai’s functions with in-house staff.
Just between 2015 and 2016, revenue from these six customers plunged from $380 million to $250 million, and is likely to continue heading lower. The losses from legacy customers have largely offset the company’s gains from its fast-growing suite of cloud security offerings.
Limited Upside if No Sale: Akamai may be up for sale (see more below). But if there’s no deal, AKAM stock could find itself in trouble up here. AKAM stock is up near 52-week highs and has rallied from the mid-$50s up to $72 since December. A large portion of that came from activist moves rather than earnings.
Analysts have a consensus price target of just $74, which is only marginally above the stock’s current price. The lack of a dividend keeps the stock from appealing to income investors.
And unlike many tech companies, Akamai doesn’t have a fortress balance sheet; it has a modest $4/share in cash. Earnings are about to surge this year, but AKAM stock already ran up and might not have much room left to move.
Three AKAM Stock Pros
More Security Threats Coming: The WHOIS website domain registry tool is in grave danger. Thanks to a European privacy law that goes into effect next month, website owners will soon be able to keep more of their contact information private.
This is potentially a big threat to internet safety, as bad actors would be able to operate with more secrecy. Security firms have long relied on WHOIS to help keep criminal activity in check.
With a weaker WHOIS going forward, expect more hacking, malware, viruses, and so on. While that’s bad news for the average internet user, it is good news for security firms. More media attention on cybercrime is likely to lead to increased spending on security services.
Akamai Is Expanding in Security: Security is a key market for Akamai going forward. Right now, security is only about 20% of Akamai’s overall revenues, as its legacy content-delivery business has overshadowed it.
But now, cloud security is growing at about a 30% rate, and as noted above, this could accelerate. To sustain a higher valuation for AKAM stock, the company needs to get a better growth story. Cloud security is a lot more interesting than some of the company’s other divisions. As such, as this segment grows, the market might support a higher price for AKAM stock overall.
Strategic Review: In January, Akamai announced that the company has engaged Morgan Stanley (NYSE:MS) to review strategic alternatives to increase shareholder value.
That move likely comes after pressure from Elliot Management to shake up the company in December. Elliot owns more than 6% of Akamai’s stock, certainly a meaty enough position to get management’s attention. Needless to say, a sale could send AKAM stock way higher in a hurry.
AKAM Stock Verdict
Akamai stock should continue to see volatility this year. The potential remains for a big jump at any given time if the strategic review leads to a shareholder-friendly outcome. Additionally, with tax reform, earnings are set to accelerate dramatically in 2018. While the company has a high trailing PE ratio, the forward PE is just 20.
That said, Akamai has shown fundamental weakness in recent years. There’s a reason shareholder activists showed up in the first place after all. Core customers are moving away from the company, and profit margins are slipping. Cloud security is an exciting growth area to make up for those shortcomings, but that might not be enough to keep earnings growing quickly past 2018.
At the time of this writing, the author owned FB stock. He had no positions in any of the other aforementioned securities. You can reach him on Twitter at @irbezek.