Akamai Technologies (Nasdaq-AKAM) is priced at about $51.00 per share giving it an enterprise value of $7.72 billion.
If one annualizes the quarter ending June 30, 2006, Akamai has revenue of $402 million, EBITDA of $95 million and Net Income of $45 million. Therefore Akamai is trading at 19x revenue, 81x EBITDA and a P/E ratio of 171x.
So at current prices, if Akamai's operations performed the same in perpetuity, it would take Akamai 81 years to give an investor all their money back. That is a return on investment of a little over 1/10th of 1% per year. Obviously investors think Akamai will perform better. It is already expecting 50% growth next year.
Is this a sustainable long term valuation? Akamai would have to grow 50% per year for about 5 years straight AND preserve existing cash flow margins in order to begin to start to enter a zone that wold justify an $7.72 billion valuation. (Assume a $500 million cash flow in 5 years trading at 15x cash flow. Still an amazing multiple for an Internet-based network services company but not a software company.)
Don't misunderstand, I am not arguing Akamai is a bad business. Akamai is in fact a great business. Today it is the provider of choice for delivering digital media to the network edge. Everyone needs faster streaming media. Akamai says it does it 2.5x faster other providers.
Akamai can do this because it has 20,000 servers in 2,800 locations in 660 cities on 1,000 networks in 70 countries. It has global scale. Equally importantly it owns and licenses some special sauce that "predicts" user requests and therefore reduces data requests that flow over the Internet.
This scale and proprietary intellectual property allows Akamai to enjoy gross margins of about 78%. It is only forecasting a capital expenditure requirement of $50-60 million next year, a little more than this year, and not much for a network with $600 million in revenue.
Those margins are the margins of a software company. Akamai CEO Paul Sagan likes to compare Akamai to big software companies. He recently told analysts, "I think the number today (i.e. software companies) is 15 that have $1 billion in revenue. That's the club we are going for."
I simply believe these margins and growth are not sustainable. Another way to say that is I believe in the long-run Akamai is more like a Service than a Software on the SAAS continuum? This means I believe as competitors enter the market (and what IP network does not want a faster network delivering digital media and applications?) Akamai's margins erode and growth slows. I don't believe the intellectual property or scale are sufficient defenses. Sixty million in capex is a rounding error at some networks and all network are getting faster at content distribution every day.
I could be wrong but I own no Akamai shares. For full disclosure neither do I have a short position in the stock.
