The Web video boom has been good to Akamai (AKAM), one of the companies that pushes video streams and downloads to your computer. But now that watching video on the Web is commonplace, and most Americans have high-speed Internet connections, growth in that area of Akamai’s business has started to “moderate.” Akamai CEO Paul Sagan said it in July during the company’s Q2 earnings call, and CFO J.D. Sherman reiterated it today in a fireside chat at Citi’s annual tech conference.
So what’s next? Better quality video, like HD, Sherman says, is one area for growth. That promises to push fatter streams and bigger downloads over the Web to your computer and TV, which should translate to revenue growth for Akamai.
When will it happen? Not overnight — Akamai estimates that just a low, single-digit percentage of U.S. households have enough bandwidth to support HD streams. But eventually, we expect to see Web video quality improve, which should benefit Akamai.
One development that could get in the way of Akamai’s plans: Bandwidth caps, like the 250 gigabyte monthly cap that Comcast announced last week for its broadband Internet customers, and overage charges, like Time Warner Cable is considering charging.
Mark: Akamai is the leading content delivery network on the Internet today.
J.D.: Background on company — 10th year in existence. Incorporated on August 20, 1998. Close to $800 million revenue.
Video: Media growth simplistically has three elements that are going to drive it — the amount of users, the amount of time they spend online, the quality or the richness online. The number of users are growing — an organic growth not a rapid growth. Time consumed grows geometrically. We believe that over time the IP will consume more and more of the amount of media that people consume in their home. Quality right now is in the 300-400 kb range. HD takes that to 500-1000 gb range. As the time grows (from 10-15 mins to a couple of hours). So the time increases and the quality increases, now you’re talkking about 500 TB per second.
When you think about the media business, we think that’s probably our fastest growth area in the next three to five years. The driver is quality and being able to deliver that quality to scale. The second driver is advertising. The ad models online are moving from selling a page to selling an auidence.
The second area where we see a lot of growth is in commerce. Growing rapidly in the first half of 08. Online commerce business continues to grow 20-25% to year. We grew about 50% y/y in our commerce vertical. The commerce sites are getting richer and more dynamic which is where we provide very unique capabilities to our commerce customers.
The newest area is in enterprise applications. More and more you’re seeing companies move applications online. As more and more people work from home and as applications go into the cloud. While that business is a small business today ($40-50M), it’s one in which we see tremendous opportunities.
Mark: Started off by talking about the potential growth outlook but at the end of the day the business model runs on traffic. How do you think about what kind of traffic growth you’re going to see over the next three years. What’s the compound databit growth that you’re structured for over the next three years?
JD: We’re not building out data centres so we’re not making a long-term bet on the terabits of data we see coming. We’re making incremental investments and overlaying them over the public Internet. That allows us to be very flexible about where we put new capacity. In terms of the rate of growth. Over the last couple of years we saw a tremendous amount of growth related to broadband adoption. This year we’ve seen that moderate a little. I think we’ll see a second wave as we go from 1 TB/s to 500 TB/s. We think in order to scale, you can’t do that from a centralized architecture, you have to do that from the edge where the capacity is the most abundant and the least expensive. I think what we’ll see is it will be a little bit slower to come but bigger than most people expect.
M: What are the next inflection points (like broadband)? Mobile? HD?
J: I wouldn’t be surprised to see the same kind of thing (broadband) to happen with HD. The new player technologies enable a lot of interesting things to happen. Is that end-user pipe capable of a 5-10 MB stream. Today consumption of rich media happens on your laptop — lean forward — that’s a lot different than the lean back media.
As volumes grow, prices have to come down. The price can’t go up 500x for our customers.
M: When the advertising solutions for online video are figured out, there will be a growth spurt.
J: We’ve seen some foreshadowing of that happening. In 2000 it didn’t matter how well you sold online, but that started to change. You also saw that in the social media space in a very rapid time frame. When social media emerged about two years ago, they didn’t have a way to monetise the rapid growth. So Akamai lost out on that in the beginning. But then companies like MySpace and Facebook started to put an emphasis on quality and Akamai started to win.
M: Customer event recently. Any takeaways you can share?
J: It was our first customer conference and we were oversubscribed. Even in this economic environment it was a very upbeat conference. We have a very broad diverse set of enterprise customers, but they were all focused on the evolution of online business. IN the media space there was a lot of talk about ad monetization. In the commerce space there continues to be a lot of optimism and growth. The customers see their offline businesses shifting online. We spent a lot of time talkiing about our dynamic site acceleration abilities, and demonstrating how impactful that is on their business model.
M: AKAM stock has been under some fairly significant pressure from economic impact and competitive pressures. Talk through both.
J: Economic: Not surprisingly customers are more cost conscious. Their IT budgets are getting tight, you find yourself negotiating with the CFO more often because of the cost pressure on their general business. The real imperative by customers to get these business models to work, we have to do our hard work in demonstrating the value of Akamai performance and functionality to win those accounts. Over the life of Akamai, volumes have always increased but sometimes they’re growing very rapidly and sometime they were growing less rapidly. When volumes are growing rapidly, prices decrease rapidly (and vice versa).
When these media companies are thinking about these models, they’re thinking in terms of the next three to five years and they know they have to drive costs down to make it work.
M: Is the implication that when the macroeconomic climate improves, you could see an acceleration in price pressure but volume would also grow rapidly?
J: Prices are going to come down. It’s just like the semiconductor industry, or the IT industry. I think you’re going to see is the economic impact on whether customers will be more reticent to roll out new features.
M: The volume slowdown isn’t because of each of us using the Internet differently, it’s because of the corporations slowing down?
J: I think that it’s the slowdown of the amazing broadband growth. In two years we went from customers consuming static images to 300K/s video. That’s the natural course. Overlay on top of that the macroeconomic conditions, where customers are more cost conscious and more reticent about pushing the envelope in new HD offerings.
M: Do you think the segment has become more competitive?
J: The segment is very competitive perticularly now and particularly in the media space. But I would say that we’re to the point where a customer always has an idea of the competition. I don’t see that significantly changing. I do believe that there are a couple of things that we do that drive our position in the marketplace. We sell more and more value to customers — we’re more sticky. The second is that we scale with these guys. We can demonstrate to them how they can grow their businesses with Akamai.
M: You seem to have attracted some very large well funded companies like AT&T getting into the space. Has that affected you?
J: Whenever a big guy like that comes into the space, you take them very seriously. OUr story against a network based competitor is they’re going to deliver the content over their network well but they can’t deliver the quality to the end-user. The largest network in the world has a single-digit percentage of end-users. They’re going to have trouble going to Verizon and say we want to be a CDN so we want to put servers on your network.
M: Thinking about a stock repurchase? Do you have the authorization?
J: That’s something we consider. That would certainly be something that would be accretive. But I think in this marketplace it’s great to have the flexibility to make some strategic moves particularly as valuations get somewhat reset. Our first choice of use of our strong balance sheet would be strategic investment.
Q: How many of the top 25 media companies are 90-95% Akamai customers.
A: A lot of our big guys will dual-source a bit of their content, not as many as you would expect. It tends to be the content where performance matters yet. Our customers use competition to keep us in line. We’re certainly the #1 provider of the vast majority of the media companies.
Q: On the last earnings call, there was an auto retailer that saw a significant increase in conversion rates after becoming Akamai retailers. In the commerce business there are tens of thousands of businesses of that size. Why aren’t we seeing more adoption of Akamai?
A: We’ve got penetration of 77 of the top 100 retailers, but when you go down to retailers 101-500 you have some pretty substantial companies, but we haven’t reached those guys. That’s going to be something you see us invest in. Do it yourself is still the predominant approach for those guys and we can make inroads on that.
Q: As media grow and stays competitive can we expect to see operating margin pressure?
A: Over the last couple years gross margins came down by 6 points, but at the same time our operating margin grew by 10 points because that business scaled. In some sense it’s a different business than our application performance business because it’s more like a software business. Our solutions and our deals with customers have two elements — delivery, and there’s a software aspect — how we manage that delivery. When you’re talking about a media customer, the delivery aspect is huge. When you’re talking about a retailer, there’s not much delivery but a tremendous amount of software.
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