Akamai Technologies, Inc. (AKAM) Earnings Call Transcript & Summary

Good morning, good afternoon. Welcome to Morgan Stanley's Day 1 of our TMT Conference for 2021, the virtual version. My name is Keith Weiss. I run the software group here at Morgan Stanley in the U.S. and I'm very pleased to have with us from Akamai Technologies, both CEO, Tom Leighton; as well as CFO, Ed McGowan. Gentlemen, thank you for joining us this morning. And -- but before we get started, I do have to run through some brief disclosures. For full disclosures from Morgan Stanley, please see our website at www.morganstanley/researchdisclosures. With that out of the way, again, gentlemen, thank you for joining us. It's great to have you again at the Morgan Stanley TMT Conference.

So Tom, I want to start with you on a big picture question. Last Friday, you guys had an Analyst Day. You went through the overall Akamai business in really good detail. Anybody who wants to dig into the story, I would definitely tell him to take a look at that Analyst Day. I think you guys did a great job at sort of diving into the business and all the various components. You've been at this for a while. You were one of the pioneers in the industry, really helped drive the evolution of the Internet on a go-forward basis. From a high-level perspective, if you take a look at the sort of the set of opportunities in front of Akamai today, how does that compare with how you were thinking about the business 10 years ago or 15 years ago in terms of what the potential for Akamai is on a go-forward basis?

Yes. That's a great point. It's -- I've never been more excited about our future. There's just incredible growth opportunities ahead of us in security and edge computing. And we're in a great position to make a real difference in the world. We've got a great base to work from with our edge platform, which is really the only true edge platform with 4,000 points of presence close to all the end users. We've got a world-class customer base. We've got over 8,000 incredibly talented and very experienced employees and a large and very profitable business. We generate the cash that we need to make investments for product development and innovation for future growth. And we've also got strong tailwinds with increased traffic from OTT and e-gaming, huge increases in cyber-attacks and their sophistication. The headlines, as bad as they've been, just keep getting worse there. And you've got the emergence of new technologies, like 5G coming, which I think can truly enable IoT. And of course, as you get more devices out there, security becomes an even bigger issue. And we know we've got a strong leadership team with a track record of very substantial success. So as I think about it comparing to 10, 15, 20 years ago, we've never been in a better position, going forward. And it's really exciting.

Excellent. Got it. Ed, maybe to bring you into the conversation, what is the balance is that investors are trying to understand as we head into 2021. We see a lot of good secular trends coming into play, like Tom was talking about 5G starting to spur IoT, edge computing with more and more development on the edge, the OTT and the trend that we've been talking about; and security, I think the priority for security is rising into 2021. So a lot of really nice tailwinds behind the Akamai business. How should we think about that in contrast to potential sort of tough compares, if you will? You guys did benefit from work from home, particularly in the beginning part of the crisis when we were all sitting on our couches, I guess, and playing a lot of gaming. Can you help investors contextualize the secular tailwinds versus the effects from the crisis last year?

Yes. Good question, and thanks for having us here, Keith. I'd say the first one, and the obvious one to get your head around is traffic, right? So we did see a significant amount of traffic, really, call it, 2 years' worth of traffic in a very short period of time. The nice thing is, I get asked the question a lot, is that durable? Is that going to continue? And the trends that we're seeing right now suggests that, that's going to continue. That we saw a nice rise in the traffic level that we see on a call it a day-to-day basis, and that's certainly lasting here kind of as we're getting out towards the end of the pandemic, and I expect that will continue. It does make for a tougher compare. As I said on my call, the Q4 earnings call that we expect this to be a more normal traffic year. So when you're stacked up against the year, where we saw double-digit growth in media, it's just a harder compare as we go year-over-year. We also saw some strong benefit in our security in a number of areas. Access control, for example, when people are rushing to get out of the building and work from home, we saw a big increase in our EAA product. And it's something that once somebody adopts that, you typically roll that out to more users rather than something you'd pull back on. So I think that's a pretty durable trend. With Asavie, we saw the benefits of kids working -- going remotely, remote schooling and the need for secure access for devices and whatnot. I think that's going to be pretty durable here, certainly for the next several months going into the summer and hopefully next year as well. And then just in security in general, more attacks. So more people working from home and away from the branch offices. There's more opportunities for the bad guys to hack, and we saw demand across several products, including Prolexic, we saw a resurgence in the third and fourth quarter there. So I'd say a lot of good things came out of the pandemic for us from a tailwinds perspective. Obviously, some headwinds, too. We had couple of verticals that are really challenged that had some demand destruction in travel and retail. And as we've talked about, that's going to take some time to work itself out. But I'd say, in general, I think we're in pretty good shape. But just a tougher compare year-over-year from a growth perspective.

Got it. Before we start digging into the individual segments, I want to get you guys' perspective. Coming out of the Analyst Day, you guys gave a pretty detailed kind of set of targets on how you think the various parts of the business could grow? When you summed it all up, there was a 3- to 5-year growth range of sort of 6% to sort of 10% CAGR on a go-forward basis. How should we think about the elements that have to hit right to get to that 10% or get above that 10%, the elements that would cause frictions and gear you towards the lower end of that? How should we try to like align our expectations, so what are some of the core drivers we should think about in that range?

Yes, sure. I'll take the first half of that, Tom, and then you can jump in. So I think if you look at the -- obviously, this year, we're starting off with our guidance kind of at the lower end of that range, coming off of an 11% growth year. So a tough compare. But it's really just, I'd say, the magnitude of the different trends. So for example, the traffic growth, how much OTT traffic growth do you see, the more traffic growth you see, the higher end you'll be on the target for CDN. Access control, I think, is probably one of the biggest variables, one of the biggest TAMs that we're going after with enterprise security and the type of traction that you get there. The timing and size of M&A that we do, depending on -- if you're doing M&A earlier on and you can scale the company faster, you obviously can set yourself up for faster growth. And then on the flip side, it would be the other end of it, right? It would be slower traffic growth and not as much traction or it takes us longer to get the kind of traction that we believe we can get in things like access control. Obviously, the sale of new products. We've launched a number of new products, Page Integrity last year. We've got multifactor authentication coming out in another couple of quarters, and we've got account takeover in the fraud space. So really, it's just a question of the traction that you get in those different verticals with those new products and how quickly you can start to ramp them. It's really just going to be the difference between the 6% and the 10%. Obviously, we think we laid out some pretty aggressive goals, and you get to the higher end, certainly, if we can execute well.

Got it. Got it. So I want to start digging into the security segment. Before I get started here, I just want to remind everyone in the audience. If you do have any questions, you could submit those questions vis-à-vis the webcast, it's going to show up on my screen, and we'll try to get to those towards at the end of our session. But going back and diving into the business, I think security has been really -- I think the growth highlight of the story over the past couple of years. And I think it's been the part that surprised investors to the upside in terms of the durability of that 20% growth. And you guys talk to a durability of that 20% growth over the next 3 to 5 years on a go-forward basis. I think one of the big elements that give you guys that confidence is the fact that there are multiple segments of growth within security. You guys talk about, I think, it's 4 over $100 million businesses today by the end of this year. With Access ramping up, I'm guessing that's going to be 5. Can you talk to sort of where we are in terms of the different businesses, what are the core constituents that are driving growth today? And how should we think about sort of the handoff, if you will? Is it one to the other? Or are we just layering on growth on top of growth?

That's the beauty. It's more the latter. And as you mentioned, that as we exit this year, there'll be 5 businesses at over $100 million, which is -- it's great. You've got App and API protection. That's your web app firewall product, where we have a very strong market lead, last year, grew at 30%, got to over $650 million in revenue. And there's new products there as well. Ed mentioned Page Integrity Manager, which is off to a very fast start. We just released that last year. And as we talked about at Analyst Day, we're looking forward to very strong growth rates there, well into the -- over 20%. And layering on top of that, you've got fraud prevention, and that's where we have our Bot Manager capability is another very fast-growing product. We did over $175 million last year, grew at 36%. And looking forward to strong growth rates going forward as we move deeper into fraud prevention. And that's all about making sure that the entity that creates and accesses an account is the entity you think it is. And there's a lot of room, I think, for growth there. This is a big deal today in a lot of industries. And then you have the network security segment, which has 2 big pieces: infrastructure protection. This is where you think about your DDoS attacks. And I think there was some feeling that DDoS is old news. That's not true. Last fall, you had the ransom DDoS attacks. And we had dozens and dozens of major enterprises turn to Akamai because we're the only company that can handle the big attacks out there. That's almost $200 million in revenue. It grew slower last year at 9%. But there's capabilities there we can layer on new services on top of that. We were conservative in our 3- to 5-year guidance, which we hope to exceed for that piece. Then you got access control. And there's a lot of growth potential here. It was small for us last year at $50 million. But as we said, we're hoping to double that to $100 million this year. And that has capabilities that some folks talk about as Zero Trust or the SASE model. But we also have unique components there, for example, with the Asavie acquisition and services that we sell-through our carrier partners. It's branded under their name. So for example, Comcast business security, you see ads for that. That's Akamai. There's -- if you want to secure your cell devices for an enterprise or even now with remote learning, you got a lot of students that need to have a secure way to get into their school. And that happens in the SIM card layer, and that's Akamai doing that. So that's one reason that we're really excited about the growth potential there over the longer-term as well. And then, of course, security services. Now we do a lot of work to make our platform easy to use for our customers, very DevOps friendly. But in the area of security, what we're seeing is that it's such a complicated landscape and moving so fast, that our customers want us to do more of it and manage it for them. So we have our managed security services, which is also a significant component of revenue and where we have a lot of expertise. And all of this builds on top of the Akamai platform as a whole. And so I think that creates additional synergies. And it's what's leading to very strong growth. Last year, over $1 billion, growing 25%. And our goal over the next 3 to 5 years is to keep that in the 20-plus percent range. And we're optimistic that we'll be able to do that.

Got it. Can you touch on the opportunity for selling additional security into the installed base, how penetrated are you with sort of the broader solution portfolio and where are the key areas for potential upsell within that base?

Yes. So Keith, we took a couple of stabs at it during the Investor Day, and I encourage people to take a watch of whether it's myself talking about it or P.J., who's running sales, we looked at it from a number of different lenses. First of all, there's about 60% of our customer base today has a security product. And only about 1/3 have more than one. So there's a ton of room within the installed base, and we showed the penetration within the top 500. We showed the penetration across all of our customer base. You could see that it's still kind of early days for even a product like Kona Site Defender. Well, it's high penetration in the top 500, it's only about 1/4 penetrated in the overall installed base. So there's a long way to go there. But you got to think about how, as Tom was talking about, some of these products how they layer on top of each other. Anyone who has purchased Kona Site Defender would have a natural need for Page Integrity Manager, right? So most websites today have some type of third-party content that you need to secure. There's been some pretty nasty breaches that have happened as a result. And this solution is just a natural addition to what we're doing with Kona Site Defender. And then any company that has purchased security from us, we're leveraging to have the conversation around enterprise. So there, some of our bigger verticals might be in things like manufacturing, anyone who has a lot of customers. So there's a tremendous room to grow there. We showed penetration rates kind of in the, call it, 10% range, when it comes to that product. So there's an awful lot of room to go with our existing customer base. And then as we've talked about in the past, most of our new customer additions are security first. So they're coming to us in a Protect and Perform as opposed to in the past, it used to be about Perform and Protect. Now it's companies coming to us, looking for security first.

Got it. And that was going to be my next question was the degree to which the security portfolio has been able to drive new customer adoption. And it sounds as though the answer has been -- that's been the strong driver of customers on a go-forward basis. Any way to kind of quantify that in terms of how effective a means of new customer addition, it's been for Akamai?

Yes. Go ahead, Tom.

Yes. Most of our new sales are driven by security. When it comes to content delivery, we're very well-known in that space. And there are new markets there in terms of geographies where we're doing a lot of new customer adoption. But by and large, on a global basis, the vast majority of new customer sales is led by security. And Ed, maybe you wanted to add some color on that.

Yes. So we don't break out the new customer acquisition. Obviously, most of our business today comes from our existing installed base but new customer acquisitions have been picking up over the last couple of years and starting to be a bigger growth driver for us. And certainly, as we get into some of the newer security areas like access and our threat protection products and their enterprise security suite. You're going after a whole new set of verticals that we're not typically strong in. So if you think of things like health care, education, et cetera, it's not really an area that's traditionally a leader for content delivery, but certainly for some of our other security products it is.

Got it. Got it. And then I wanted to ask a question about M&A and how that plays into kind of your development philosophy on a go-forward basis. And also that growth equation, if we're thinking about the durability of 20%-plus growth over the next 3 to 5 years. To what degree does M&A play a role in that?

Yes. So it's obviously going to be part of our strategy. It's been part of our strategy. We tend to do smaller acquisitions. We're not opposed to doing large acquisitions. I don't think we're anticipating doing anything transformative. That's not in our plans. We wouldn't need something transformative to do that. But we do look at all different types of acquisitions, you go through the standard build by partner. I think it's, in a lot of cases, easier to buy a company that's subscale and help scale it. You just get to market much faster. We saw that with Asavie. With less than a quarter's worth of free cash flow, we bought a company and we've accelerated its growth rate. If I look at what our plans were going into the year, our acquisition model thesis, we're well above that right now. And we think there's lots of opportunity to scale it. So we'll look for scale assets. In terms of what we're anticipating in our plans, I would say, kind of a more normal rate of acquisition that you've seen us do. We'll maybe step it up a little bit from time to time. And we'll certainly look at larger acquisitions. The challenge has been valuations, especially in the security space it's been a little crazy. So we're very active shoppers but very disciplined buyers.

Got it. Got it. That's super helpful. And then, Tom, maybe a bridging question, so to help us change gears towards the CDN or the edge part of the equation. Can you talk to us about how the network security side of the equation and a lot of the stuff that we talked about within your portfolio is like the access solutions and whatnot. How that's starting to converge with the network side of the equation, that it's very hard to sort of do the network security without having a good fundamental understanding of the network. And as those start to come together, it would seem though it's given a nice natural advantage to Akamai, given how much visibility you have to that network and how -- basically, how integrated you are into the broader public internet?

Yes, it's a huge advantage. Our security solutions run on the Akamai Edge platform, which means that we can provide much higher volume of defense, much more intelligent defense because we see a huge portion of the traffic of the Internet. Probably a large majority of all the DNS queries are handled by Akamai under the covers. You don't see it because it's handled through our partners, and often under their name. So we have the best intelligence by far. And we can apply this in real-time to our defenses. And we can apply the defense far from the target. These days, if the cyber-attack ever reaches your target, you're doomed. And we prevent that from happening, and we're really unique in having the edge platform and all this network intelligence and experience. And in fact, the same software, the same request response flow of the traffic that's doing acceleration and delivery is applying the security. So it's all done together. So it remains very fast as well. A lot of companies, you buy their security product and you can't turn it on because it crushes your performance. And with Akamai, it's really unique, you get the security product and suddenly your performance just improved.

Got it. There's a client question that's come in that I think is sort of spot in mind kind of with that answer, the idea of pushing security towards the edge. And something that you guys are talking more about doing is sort of enabling more developer capability at that edge. And I guess if you bring the 2 together, there's kind of [dev-stack option], does that extend to the edge. And so the question that the client was asking specifically because I don't want to mess it up. You mentioned a security solution that's embedded at the SIM level. As companies like Twilio introduce products like super SIM cards for embedded IoT applications, are you seeing more developer interest in using Akamai Security Solutions for embedded IoT applications?

Yes. And maybe there's 2 different components there. The nice thing about our Asavie solution is that you don't need a special SIM card. You can use it for devices where you can't even do programming at all on the device. You can't have a client application. You just simply point to SIM card through our carrier partner to Akamai. So all traffic, using an ordinary device, sitting in a truck going somewhere, comes to us. And we make sure that wherever that device goes on the Internet, it stays secure, it doesn't bring in malware. So then when it talks in the corporate network, that corporate network is locked down. And so that's an environment where you can apply the security for all these IoT devices where you can't even put client software there. Now there's a separate issue with being developer friendly and having a programmable edge and Akamai does both. We support JavaScript code from our customers and their developers directly on our platform. We talked a lot about that at IR day. And in fact, we've been supporting customer code on our platform for 20 years. We were ahead of the market. We were doing these kinds of things before AWS even started, before there were containers. And we talked about WebSphere ran on Akamai's Edge platform starting in 2004 with a lot of customer applications on it. And now JavaScript is the right way to do that. That's by far, the most common language used by our customers developers. And I think that's an exciting area for growth, and we already have third parties programming on the Akamai Edge and selling their applications in the sense of an app marketplace on top of Akamai. And then being DevOps friendly is really important for us as well. Although I think in the area of security, I think, what we're seeing from our customers is some of them like that, but most of them want to even go the other way in terms of having us manage it all. Because the landscape in security moves so fast, and it's hard to get the expertise in companies to keep up that they just -- and we have that expertise, they want to pay us to just manage the solutions that we've sold them. And so there's a little bit of going in the other direction, I would say, when it comes for security.

Got it. Got it. So that's a good segue into sort of the broader conversation on edge apps. It's definitely a hot topic of conversation amongst investors right now. You guys talked about it a fair deal at Analyst Day, you talked about a 30% plus 3- to 5-year CAGR there. Can you talk to us a little bit about Edge Workers, EdgeKV, what's the opportunity that these solutions are facing out? What are the typical type of edge applications that your customers are building out? And then maybe to wrap in another client question. Does this give you capabilities, particularly when you use that JavaScript engine in the streaming gaming part of the equation, is there opportunity there in particular?

Okay. So Edge Workers is our serverless edge computing offer based on JavaScripts. So we deploy Chrome V8 engines to our edge servers in thousands of locations close to end users. So nobody has that kind of capability out there. EdgeKV is our key value store so that handles cases where you need state, for example. And they're used for all sorts of applications, API orchestration, personalization, search engine optimization. Compliance, that's really important in a lot of countries today. Virtual waiting rooms, we're doing a lot of that now, as you can imagine, with lineups for COVID, vaccines and so forth. Overall, I think the application domain is very large and also helps our customers. As they move closer to the user, it gets faster, it's more scalable and offloads cost for our customers. It's a lot less expensive than using traditional cloud deployments. And as you get an app marketplace built up, I think that makes it even better for Akamai. So early days, but I think a really exciting opportunity for us.

Got it. So we have about 3 minutes left. I'm going to end on a margin question for Ed because I love margins. So you guys have done a great job of expanding operating margins over the past several years. You've seen the capital intensity of the business come down by about 2%. And it seems to me that a lot of this levers a higher value security business increasing as a percentage of the overall mix versus the very CapEx-intensive kind of core streaming businesses on the other side of the equation. Can you talk to us about the potential for further kind of CapEx efficiencies on a go-forward basis, what happens as that security mix starts to -- or keeps improving as a percentage of the overall mix? And could this potentially create upside to your 3- to 5-year goal of that 30% to 32% operating margin?

Yes. So as we laid out on the IR day, we showed sort of the relative profitability. It's hard to get it exact because you're allocating a lot of costs, but I think we've done a pretty good job of breaking it out. And specific to CapEx, I think there's sort of 2 levers you need to think about as the business mix starts to change. So as you get out to, say, the 50-50 mix from 1/3 of security today or just a little bit over that, you will see maybe a point or 2 as your security CapEx is, call it, in the 1% to 3% range for kind of your network CapEx, which is really what you should be looking at when you think about the capital intensity. We do capitalize R&D, but that's -- GAAP requires you to do that, think about that as R&D spend. So really on that network line. The second part is, what does the mix of traffic growth look like going forward? So if you've got an acceleration of OTT, that's going to be more capital intensive. So your CDM business might be a touch higher from a capital intensity standpoint, if you see lower traffic growth for OTT, it will be less capital intensive. But as you start to move that mix shift and you go out to, say, 60% or greater of security, you could see that overall capital intensity of the business go down because the security business really is kind of that low single-digit network capital intensity.

Okay. Got it. And then in terms of -- with that potential for further efficiency, is there a potential for getting out of that 30% to 32% range that you talked about at Analyst Day if you garner at it? Or does that just get pushed back into the business in terms of incremental investment?

It really depends, right? I mean, you could see it possibly. I mean we're obviously going to be working on efficiencies in back-office G&A. We'll be looking at things on our cost of goods sold line. Like, look at taking third-party cloud spend, for example, and bringing that in-house and building out that capability. So we're going to be very focused on margins. I think what we're trying to signal, though, is you want to maintain that healthy balance of investing back in the business for fast-growing products. There could be some M&A that might knock you off course for a year or something like that if you were to do a larger acquisition until you scale it. So we're just trying to maintain some level of flexibility, but obviously, much more profitable business. It scales very well. And part of our go-to-market strategy is going to be leveraging channels more than we do today. So there's a possibility for it. We just don't want to commit to it now because we want to maintain that flexibility to invest in fast-growing products.

Fair enough. And those investments definitely have been paying off when we see sort of the success that you guys have been seeing in the security business. We're pretty bullish on security spending into Calendar '21. So that should be a good tailwind for the story. And unfortunately, that takes us to the end of our allotted time slot. But Tom, Ed, thank you so much for joining us and walking us through the latest on what's been going on with the broader Akamai story, a lot of exciting components under the hood. So a lot for us to dig into. Appreciate you guys taking the time. Thank you so much.

Thanks, Keith.

Thank you.