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

Good morning and thanks, everyone, for joining us. My name is Sterling Auty; I'm the software analyst here at JPMorgan. Welcome to Day 2 of the 48th Annual Technology, Media & Communications Conference here at JPMorgan. Very happy to have with us Tom Leighton, who's CEO and Founder of Akamai, for our first session of the morning. Tom, thanks for joining us.

Good to be with you.

All right. Listen, just to -- let's kick off with 2020, obviously was an unprecedented year in terms of the pandemic. And first of all, thank you; as a father of 4, in terms of the Internet traffic that went through this house between remote learning, gaming, streaming and the rest of it, it was very impressive. But maybe can you, for context of the listeners out there, give us a sense, what was 2020 like in terms of your business on that side and we'll obviously dive into security as well.

Yes. Obviously, a lot of traffic, more or less doubling a whole extra year's worth of growth sort of overnight. So big difference there. We deployed a lot of capacity to keep up and stay ahead of the demand. So exciting that way. And we were really pleased to make a big difference to the Internet. And not just for the entertainment, which is associated with gaming or OTT, we did a lot of that. But also for business, making sure that even as the Internet got loaded up, that business applications were faster than ever for commerce and for banking. That makes a big difference. And for security, attacks rose quite a bit. I mean attacks are always getting worse. But I think with the increased reliance on the Internet, that target is bigger than ever for the attacker and the various kinds of extortion, attacks you see, they're worth more. And so companies, in some cases, pay and organized crime is a big deal on the Internet. And not just for business, we made a difference for kids doing remote learning with our application that secures the cell phones and the devices that the kids are using to access the school content and making sure that they don't go where they're not supposed to go, especially when the school itself has distributed these devices for the kids to be able to learn remotely and to make sure that the kids themselves aren't exploited by the attackers. So really across the board, we were very pleased to make a big difference, I think, during the pandemic and going forward.

So as the Internet has evolved, at this point, what portion of the Internet's traffic actually flows through the Akamai network?

Well, we know how much we get. We don't have a perfect estimate of the rest of it but it's a lot. It depends on what's happening at any given time. It depends on the geography. We've had many carriers tell us that during certain kinds of peak events, we can be close to 1/3. Cellular networks have told us, in some cases, we're more than that. And then in some cases, we're less. We're obviously one of the biggest consumers of content and deliverers of content, consumers of bandwidth on the Internet. And in terms of security, we work with pretty much all the world's major banks, all the world's major commerce companies. So -- and not just traffic but transactions, huge benefit there.

Listen, you've been public for a long time, but there's always new investors that are coming to the story. So just to balance out for those that are new versus those that really know Akamai, how do you look at your business? In other words, how does your business break down into what segments? And how big are each of those segments?

Sure. Well, first, we have one platform, the Edge platform. And we use that platform to do a lot of different functions for our business customers. Everything from delivering, say, media content. And most of our traffic measured by bits would be media content, OTT, software downloads, e-gaming, e-gaming software updates to accelerating transactions, which is a much higher value per bit. It's not a lot of bits per second, but we do one heck of a lot of transactions per second, trillions per day on the platform. And security, where we're securing content of all kinds, including your gaming account and your OTT accounts. Obviously, your bank account, your health information, protecting enterprises. So at a high level, you could think of us as security and of course, with our recent reorganization, we have all of our security products together. And that's well over $1 billion now and growing, has been growing in the upper 20 percentile. So really very strong growth there. And then you have the content delivery side of the house, which is a little bit less than 2/3 of our revenue now, about $2 billion. And that's the performance aspect, which is about half. And then the big delivery, bulk delivery, which is about half of that. So that's how it breaks up. But the key thing to think about is it's all seamless. Every server is doing all those things, including edge computing, and it's done as part of all the same transaction, totally integrated. If you buy our security solutions, we'll make your application faster, just as part of applying security because it's all part of the same transaction between a client and a website or an application.

So we talked a little bit about COVID in terms of 2020 and the doubling of traffic. But can you characterize for us now that vaccines are starting to kick in, knock on wood, hopefully, the world comes out of this pandemic as soon as possible. But what kind of impacts does coming out of the pandemic actually have on each side of the business?

I think we'll see normal growth in terms of year-over-year. Last year, there was a little bit of an extra bump from being -- going from nonpandemic to pandemic and a big increase in traffic. So that gave us a little bit of extra growth year-over-year. And I think you'll see us be normal now. I think normal levels of traffic growth off of a bigger baseline. The attacks, if anything, are increasing even more. Just you see the recent headlines in there just -- it's incredible what's going on out there, and I think that's partly why our security business is growing so rapidly. There's just so much need for our services. And in many cases, we're the only company that can provide the services that we do. So I think it'll be normal growth year from here on out. It's not a situation where it steps back to be less than, say, pre-COVID levels. I don't see that happening.

So let's maybe dive into the security side just because I think that's a good segue. For investors, can you give us a sense, what are the key components of your security portfolio at this point?

So about 2/3 of the security portfolio is what we call application security. That's things like application firewall where we're the market leader by a wide margin. It's things like bot management. Again, we're the market leader by a wide margin. It's our new product, Page Integrity Manager, pretty unique in the marketplace. And even though it's not even quite a year old now, very rapidly growing. And that keeps malware from winding up on enterprise customers user's browser, where it steals their personal information because websites use so much third-party content or link to it, and a lot of that has malware. So we have a capability now that as we're delivering and securing our site, we'll make sure that, that kind of stuff doesn't happen. Major card attacks don't happen. So that's about 2/3 of the revenue. About 1/3, a little less is on the infrastructure side. That's things like Prolexic with the IP layer, routing layer DDoS prevention, protecting your DNS infrastructure. Really the Achilles heel of the Internet, a lot of people don't even think about that, but that's so important to do. And then as part of that, we have our access -- enterprise access security, which we are very pleased that it hit the $100 million a year run rate in Q1, very strong growth, well more than doubling, organically up 60% over the prior year. And we see that as a continuing to grow very rapidly and has huge potential for the future. The enterprise security space, I think, is going to be undergoing a revolution as enterprise security moves to cloud services, and we're in a great position to supply that.

Let me just take a quick second. For those that are watching it, if you'd like to ask a question, there should be on your screen, you'll see an Ask A Question button that you can click, type in your question and actually comes to me digitally. So I'll incorporate it into our session as we go along. Tom, you talked about with some excitement there, the enterprise access. When I hear that term, I know that based on my conversations, most investors think Zscaler. Maybe they even think a little bit of Cloudflare as they're coming into that market. Is that the right set of comparisons? And what is it that you're doing in that market that you think is going to differentiate versus the vendors that are there?

Yes. I would say Zscaler is a good example. Obviously, today, the vast majority of the market is in traditional enterprise players that would sell boxes that the enterprise manages themselves. That's where 99% of the market is, but Zscaler is a good example. And Akamai is in a great position because we have capabilities that they don't -- with our application firewall, Kona Site Defender and being now able to apply that inside the enterprise for applications is a huge advantage. Our performance will make your enterprise apps faster as we secure them for your employees. In fact, we've had customers buy it primarily to speed up their internal applications for employees overseas. That's a big competitive advantage for us. And things I talked about before, securing cellular devices. So all the traffic comes to us before it ever goes to the Internet. And we make sure that it doesn't go to places on the Internet it shouldn't, or maybe it shouldn't go to the Internet at all. And so for example, when a school is giving devices to kids, for remote learning, to make sure maybe it only goes to the school or the references the school has said are okay to go to. And that's unique to Akamai. And we do that with our carrier partners, the devices point to us at the SIM card level, and so we'll make sure that traffic stays safe. And I think that's really exciting when you think about the potential for IoT and 5G. Getting those devices secured is really hard and in many cases, trying to put something on the device is impossible. But if it comes directly to us, we can apply the security layer. So yes, I think we have capabilities that some of the cloud players don't have. We've now -- we were a little bit behind Zscaler, I think, in terms of the Secure Web Gateway. Now with our Enterprise Threat Protector Version 4, I think we're pretty much caught up there. Already, we were doing very well with our enterprise application access for those capabilities and tying it in with our Kona Site Defender Secure Web Gateway.

Now see, I thought where you're going to go is with the Akamai network. So I think about conversations I've had with Zscaler customers and other customers talking about early on, they had bandwidth constraints because the points of presence weren't there. And I look at the size and breadth of your network and I think it's easy for people to provide coverage in New York or Chicago, but to do it in Europe and Latin America and Asia, that's where I thought there would be a standout in terms of competition.

Yes, and it's huge, with 4,000 points of presence in about 1,000 cities around the world. That's how we get great performance. And normally, with security companies, you turn on their security and your performance grinds to a halt. In some cases, you can't even use it. And with Akamai, you turn on our security solutions and your applications get faster. And of course, there's -- we can make them even faster still, but just the base level security makes them faster. Also gives us great capacity and that's so important for the DDoS attacks. We're the only company that can defend against the large-scale attacks today. We're the only company that can help you through the ransom DDoS attacks and stop those, so you don't have to pay the ransom and don't have to worry about it. So the platform is a huge differentiator across the security landscape. Of course, it's a big differentiator in CDN. But you're right, a lot of people don't think about it in terms of security, where it's important as well.

Why do you think -- and maybe to help investors understand, the pace of these attacks are increasing, the sophistication are increasing. When you think about the colonial pipeline attack, et cetera, maybe help investors understand what's happening out there in the dark net and ability to rent bot nets, et cetera.

Well, unfortunately, it's very easy to get your hands on malware to do bad things, to get your hands on large-scale botnets to launch large-scale attacks that's unfortunately, easy to do. The prize is huge. I mean, as you see the published reports on the pipeline attack, ransom paid of over $4 million. That one was high enough profile that you saw about it in the press. But there is big money and big organized crime that's doing a lot of these attacks. And not just ransom attacks, but also theft, taking over bank accounts, accounts of all kinds, even OTT and gaming accounts at massive scale because there's economic value to doing it, and it's not that hard for them to do. You also have nation state attacks for a variety of purposes. It can be to steal intellectual property, for example, or to embed malware for later use to test responses. This -- the prize is so large that you have multiple entities out there that are reporting these attacks. And it's -- the rate and the sophistication, the scale, has been accelerating. And I think the other side of the coin is there are just tons of vulnerabilities. Just -- you can name any component you might have in your infrastructure, and it's got vulnerabilities. And it somehow -- it -- these get exploited for months or years before they're discovered. I mean Exchange Server, for goodness sake, as basic as it gets, and a lot of companies lost their e-mail. And it's another great example. Akamai was using that same Exchange Server that had the vulnerability. We didn't lose our e-mail because we had our own services in front, enterprise application access. And so we had to be an authenticated Akamai employee that had a right to use that Exchange Server before you could even touch it. And even then with Akamai in front, you don't directly touch it. You touch us. And then we go back and communicate without Exchange Server, and so we make sure that, that kind of attack can't happen even before the attack is published, and we know the details of it. It's just -- it's incredible. And with everything moving online now and more and more remote work, which a lot of that is here to stay, even past the pandemic, it makes the prize bigger and that I think fuels even more attacks.

Absolutely. And so I think one of the questions that investors have is, "Okay, post the SolarWinds breach, very high profile, Colonial Pipeline, et cetera, are you actually seeing increased activity in terms of conversations, pipeline generation that eventually could lead to even potentially faster growth in your security segment?

Yes. And that's why when we gave our guidance initially for the year, we talked about 18% to 20% growth in revenue. Now we've updated that to be low 20s. We did 29% in Q1. And yes, it's been a very strong environment for our security solutions, even at big numbers now. You talked about some other security companies. And we're more than twice their revenue in terms of security and growing at a very fast clip.

And again, just for investors, just to clarify, so those growth rates are your security growth, not total revenue growth. I just want to make sure that for their benefit.

Yes, I think there are some people that say, if you looked at us separately, and of course, there's advantages to having the whole thing together, but our security business, well north of $1 billion in revenue and Q1 grew at 29%. And then you see some of the valuations of some of the other pure-play security companies. My goodness, our valuation would be much higher than it is today if you looked at that. And the CDN business is a great business. It's not growing in revenue very much. But it's generating a lot of cash, and we use that to invest and then to grow our security business even faster.

Well, you're absolutely right on that security valuation piece. But I think that brings back -- there's been a couple of discussions out there with investors around -- even if you wanted to, could you split the company? I think the benefit is a single platform. So it doesn't seem like it makes sense or that you could even do it if you wanted to, correct?

Right. It doesn't make economic or business sense. The same request flow of data from a browser or a device into an application or a website, we're doing the security to those bids as we're accelerating them and as we're delivering them. It's all part of the same transaction. It's all the same server, all fully integrated, all one deal the customer buys. And on the CDN side, we're very profitable, generating a lot of cash for the every bit that we sent. The security side also, very profitable. We're investing a lot in R&D to develop new capabilities there. And it makes sense as one unit. But wow, the security portion, you think of the power of that business and then you compare it to some of these other companies that are pure play and you say, "Wow, Akamai should be worth a lot more, I think," because the CDN business is a very nice business and together, it's incredibly powerful.

So President Biden recently signed an executive order, really highlighting the focus on cybersecurity. And I think there's a tremendous amount of potential spend that comes with it. How does that potentially impact Akamai? And for something like that, how long does it take before that starts to show up in your results?

It takes a little while to show up in results. First, they got to actually decide what they're going to do, and that is going to take some time. And then the standards get put in place and then people adapt to that and decide their spend. So it's not an overnight thing. Probably, it takes them even a year to get all the details of what they're going to mandate out there. And the good news is the administration is doing it thoughtfully and engaging with experts to figure out what the right thing to do is. It wouldn't -- it's not going to be an overnight thing. And I think that is very positive. Just every way you look at it, it is a good thing to be doing. And it will ultimately help Akamai because we are in a great position to provide a lot of the defenses that companies need.

Absolutely. Let's switch gears, talk a little bit about the CDM business. I'll start with a question that came in here from an investor in terms of, "Can you just give a sense from a high level, what the key components of your CDM business, meaning even qualitatively, how much of the business comes from OTT and streaming versus video games?" So the kind of core components that generate the revenue on the CDN space.

On the CDN side, roughly half the revenue is from delivery, big bulk delivery and about half is from accelerating applications. Now almost all the traffic is the bulk delivery. And a slight majority of that is OTT, video kinds of things. And the rest of it, by and large, is software updates, gaming, that kind of thing. So traffic is almost all that bulk stuff and a little bit more OTT than software and gaming. And traffic growing very healthily at normal Akamai rates, which generally is faster than the Internet as a whole. And the -- we also have an Edge applications business, which includes the Edge computing capabilities And that's growing at a good clip, over 30% in Q1, well over $100 million a year run rate for that. And I think that's got a lot of future. And so as we look at the CDN business, the bulk of that $2 billion a year is in application performance and in bulk delivery. But we've got a rapidly growing segment on edge applications, which is more the compute side. And I think that maintains a very high growth rate and gets to be a bigger number and ultimately drives growth in the CDN side of the house. You think about IoT in the future, you think about 5G and the increasing need to move compute to the edge. And we're in a great position there. With all our edge servers, the same servers that are doing delivery and security are fully programmable by our customer base today, and many of them are. In fact, we even now have third-party companies writing edge applications for our platform that they go and sell to other companies and they become Akamai customers. And that's great to see.

So the business certainly benefited from the introduction of a number of OTT services. And I think about the Disney+, the Apples, et cetera, HBO. How does that annualize? So in other words, usually get it -- I would imagine a surge levels off, but are we in that normalized growth? Do we have tough compares from those? And what's left to come?

I think there's plenty of OTT left to come. And the way we're looking at it, we think there's normal growth patterns. Last year was abnormal traffic growth pattern because you did, the same time you had launch of some of those services, you also have the COVID effect. So we did have faster than normal traffic growth. In fact, you look at our peak traffic, which we disclosed, and it doubled '19 to '20, and it's much more modest '20 to '21 in terms of peak traffic. Traffic is huge on our platform, round the clock now, we're well over 100 terabits a second. So even if you try to find the low point on the platform, it's over 100 terabits a second. And just if you look at 2019, that was the peak, we were all excited when we hit 100 the first time. And of course, now our peaks are over 200.

I was going to say, I think by happenstance, I came to visit. I remember looking at the operation side, you see the screen up there and seeing as -- you had done it a little bit, but seeing over 100 terabits was amazing to see. The other thing that I find interesting is we've talked about market share in CDN business for a number of years, especially here at the conference. And you've long talked about how you approach the market, et cetera. And I'll ask the question this way. In light of some of the, let's say, less than stellar guidance that we've heard from a couple of your peers, are you starting to see some share gains or regaining share in the marketplace in this business?

Yes. And we've been talking about that over the last couple of years really. We have been growing traffic faster than the Internet as a whole, and that means that we believe we're gaining share. And you're starting to see that now with some of the other entities that are public and sort of have to disclose revenue. And so we're in a really good position there.

Another question coming in from an investor. "Can you give any type of quantification in terms of your edge use, so edge computing? And how many third-party companies at this point are starting to write code or applications for your edge platform?

Yes. It's -- I would say early days, especially in terms of third-party companies, one that we have been able to disclose is a company that builds queuing applications. And we worked with them and also, Salesforce for many of the COVID vaccine registration sites where initially, they're oversubscribed. So of course, you go to Akamai because you got a situation where you've got a lot of traffic and traffic spikes, you need good performance. And so you need to have queuing because not everybody can get a reservation at once from the back-end systems. And so in some cases, we provided the application. In some cases, a third-party company wrote -- had already actually written the application before for other purposes and they provided it. And so now there's dozens of state and national governments around the world and health agencies that handle the registration process for vaccines on using our edge computing platform. So traditionally, in the past, mostly, we wrote the applications. In some cases, customers would do it, and then we'd allow others to use the same application. But now I think exciting time for the future is when you have just third-party app companies writing to our platform. And it's easy to do with our JavaScript engine. You just -- and you just have the tremendous scale and capacity and speed. We had hundreds of billions of apps spun up on our platform in the last quarter. And very high growth rates there, and it's fast, 5 milliseconds to spin up an app, if you need another one, based on the customer request. So that's I think pretty exciting development for us.

So I think that brings up a good point. I mean how do you differentiate? Obviously, you pioneered edge computing. You were edge-computing before the term even existed. But I think the perception in investors' minds is, "Well, wait a minute, if I look at Cloudflare, look at Fastly, they've developed something where maybe you can use a lot of modern development languages to quickly create and deploy an application." Do you still have that same ease of use or because of the way that your network was constructed, does everything need to be JavaScript or with a JavaScript wrapper and is that somehow limiting to developers?

All the developers out there write in JavaScript. And I got to say, there is so much fun out there about this. In fact, one of the competitors you mentioned doesn't directly support JavaScript. They write in WebAssembly. And that's what their system runs. Now they can translate it. They can recompile it, but nobody writes in web assembly. They write in JavaScript. And if you want to tune your code, it's a lot easier to use Akamai's edge computing than it is to one of the companies you mentioned that in theory, that's been their claim to fame. It's just not true. Some of the FUD that's been put out there. And we -- I've been using the edge computing term, I think, close to 20 years. When we launched our first edge application services. Edge, Java, edge side includes WebSphere was ported to run on our Edge platform. On the early 2000s, companies like GM used it to build car configurators on our edge platform. I think the primary issue is we were ahead of our time. The world wasn't really ready to adopt it. And so what we ended up doing is writing the apps ourselves for customers. And so there's a lot of applications and cloudlets that have been run on our edge platform for a lot of customers. We've got over 1,000 customers using -- using edge computing at Akamai for over a decade. And now there's a lot of interest in it in the community, and it's getting a lot of attention. And that's great because we've been doing it for a long time at a much bigger scale and much better performance and easier to use than the competition that's just getting started there.

I just want to touch upon margins. So over the last several years, you went through a very concentrated effort to drive your operating margins, your EBIT margins went from the low 20s to 30%. So a tremendous amount of expansion that you're able to show, which is no small effort. Now that you're here, how do you manage or what are you going to do in terms of the balance of those margins versus investing for growth?

Yes. Great question. We're always going to be as efficient as we can. And we stated our goal is to be at least 30%. And as you know, we're running a little bit better than that now. Also as the security business continues to grow and become a bigger share of overall revenue and now it's about 37%. That will give some upward pressure and help on margins so they could expand. But we also want to be careful to make sure that we're making sufficient investments, especially on the security side of the house where there's a lot of, I think, future growth. And that the landscape of the attacks changes rapidly, and it's really important for us to stay ahead. And that means investing in R&D with the security expertise. So we're running ahead of our target now. That may continue, but you also may see us make acquisitions or make investments that for a period of time, could knock up down a point or two, depending on what we do and then grow back from there. So our public goal is at least 30%, and we're doing a little bit better. It's not impossible we could dip a little bit below, depending if we did an acquisition, especially when you look at the accounting of how it's treated and then we'll get back and be growing from there.

On that investment, you also kind of pointed out the CapEx portion of it, which brings up, I think Q1 was the heaviest for the year, but where are you in terms of the capacity expansion needed to drive both sides of your business?

Yes. Almost all the CapEx is on the CDN side and almost all of it is associated with the big bit delivery, OTT, software, gaming, that sort of thing. And yes, our CapEx and as a percent of revenue, will be lower going forward because we had a huge build-out over the last year, associated with the big traffic increase. And we see more normal levels of traffic increase going forward, and that means more normal levels of CapEx spend as a percent of revenue. And of course, we're always working really hard to make our servers more efficient. And I think that's something that people don't often think about. Our competitors aren't required to be profitable and aren't. And the nice thing is Akamai is very profitable and generates a lot of cash from our CDN. And that means that we're a sustainable business. And we can take that cash and plow it back in to develop new capabilities and to fuel growth and scale. And our competitors are going to have a harder and harder time. They're small today. They're a tiny fraction of us. And as they get bigger, growth rates will decline and they're going to have to get profitable, and they are not today, and they are not scalable. And that's going to become a real challenge for them. And part of that is because our software is so much more efficient from all the effort that we put into making it be efficient. And of course, we have the edge platform. The majority of our deployments are places where we don't pay for a colo, we don't pay for power, we don't pay for bandwidth. And that's just a huge advantage. And you can't get that. The competition puts their equipment in core data centers because that's all they can really do. That is the most expensive place in the world to serve content from and to put your CD in, and that's a huge advantage. And of course, that means we're also in a position to reach price points that our customers want, which is very important to a business.

Absolutely. All right. With that, I think we've hit our time right on the spot. Tom, as always, thank you. I always enjoy our conversation. So thanks again for joining us.

Thanks. Good talking. Take care.

Have a good one.

Bye-bye.