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

Good afternoon, everyone. I'm Jim Breen, internet infrastructure analyst here at William Blair. For our disclosures, please go to the William Blair website. With me today, I have Tom Barth and Rick Eskelsen of Investor Relations at Akamai; as well as Adam Karon, COO and GM of the Edge Group. Thanks for being here, guys.

Thanks, Jim. Appreciate it.

So just can you start off just briefly talk about Akamai's business? What services fall into the security and edge segments?

Sure. Yes, I mean Akamai, from the beginning, its mission really is to make the Internet fast, intelligent and secure, right? And we do that through distribution of servers that sit on what we call the edge of the Internet, so servers that sit about one hop away from your IoT devices or your phones, any device that really sits on the -- that sits on the Internet. And so our services, like you just described, sit into 2 big broad groups. One is our security bucket, and what we talk about there is we have application security. And inside app security, you can think about things like WAF, API protection, fraud protection, page integrity management, bot protection, and that's inside the application security side. We have inside security, we have another bucket called network security. And inside that, you can think about infrastructure protection. So our Prolexic service, the Layer 3 DDoS attack-type things, edge DNS that we have, so things to protect against DDOS primarily. And then access control, which is where we put our enterprise security and our secure personalization services, which are sold primarily through the carriers. And then we have our people-based security services in there, and that's our award-winning SOC, and the people that manage our security services for our customers. And so that whole bucket was around $1 billion in 2020, and that also has about a 3- to 5-year CAGR that would be targeted just over 20%. And you saw that we had on Q1 as well, accelerating a little faster than that really. But on the other side, we have our CDN business, which is my side of the business, and that also sits in a few buckets. The broader big bucket is really our edge delivery. And that's -- last year was around $1.7 billion. And that is what you think about like the origins of Akamai, right, our streaming services, our downloads, our page delivery, acceleration services in the retail, hospitality, travel spaces. And then our new space, which is edge applications, which is where we have our compute offerings, that one is around $150 million of that business, and it's growing at just over 30%, and we did over 30% growth there in Q1. And that's where our new compute solution like EdgeWorkers and EdgeKV sit inside. And then we also have some people-based services as well that sit inside the CDN offering, and they offer things like event management for big video events or higher-end support for some of our very big enterprise customers. Well, that hit it, Jim. Yes.

Yes, that's great. So let's talk about the edge side first. We had a call with you guys just over a year ago, I think, about 1.5 months ago, at the very beginning of pandemic and you were starting to see traffic volumes pick up, et cetera, because of the OTT trends. Can you just talk about what you've seen over the last year? How much of it is sort of really structural change within how people are viewing video, et cetera, looking at using the Internet, et cetera, versus where we are today? And how much of is -- was sort of pushed forward because of the pandemic?

Yes, I mean, I think you had a couple of things that are really interesting. In Q4 of 2019, you had the launch of a number of OTT platforms that were exciting in and of themselves. It put the pandemic kind of inflection point aside. You had the Disney+s and the HBO Maxes and Apple TV and Paramount Plus with their CB -- back then it was still CBS, but you had a number of those offerings coming out. And so that was already starting to drive an increase in dealership online, but the pandemic did drive that inflection, and we saw a dramatic increase of what was already a trend. And then typically something like a pandemic like that would just drive existing trends faster, which is exactly what we saw. I don't -- I think what we've seen throughout, you've also seen, the gaming industry take advantage of this, which is multiplayer gaming like Fortnites and the Call of Duties, where you had living environments that people would be inside of and their environments would evolve in real time, which drive downloads to those games, that also picked up during the pandemic. So you put both of those things together, you saw this kind of really increase in traffic that we talked to you probably about last year, and then it continued all throughout last year until it reached kind of a new peak level. And then I'd say, probably, when it reached that, let's say, the fall of last year when kids went back to school, we saw continued growth that I think I compare back to normal growth rates. So the way we've been talking about it is COVID drove a new baseline for the industry in terms of traffic, and now we're seeing normal growth that would -- for Akamai, which would be faster than normal Internet growth but growth that would be normal past then. And we're continuing to see that now into, I guess -- it's June now, so into June.

And can you talk about sort of the -- and these are some of the trends actually, I think, you started to see in the third quarter of '19, where normally you guys saw some seasonal weakness in that summer time frame because more people are outside. But third quarter '19, you had a good quarter around that part of the business. And it was -- maybe people watched less total video during the third quarter, but more of it was online, which was more positive for your infrastructure. So can you just talk about sort of the trade-offs there, that phenomenon of more hours per day, OTT versus linear versus the absolute hours per day that have changed?

So well, let's see. How do I answer that? So the -- obviously, more sustained traffic at any given point is better for Akamai, right? I mean meaning, we make more revenue that way as opposed to, let's say, a single-point event or a single-point download, and so which you'll hear us talk about, which is any line event really isn't material for us. It's really the sustained subviewership on a day-to-day, hour-by-hour basis that drives traffic, sustain traffic. And sustain traffic is what drive sustained revenue and optimal use of our platform, right, and so in terms of economics. So I don't know if that hit your question, though. Maybe ask you one more time to dive -- I'll say did that kind of cover what you -- because -- yes, what we want to do is see that. And I think that the platforms that you see online today, driving more and more subs, you're seeing people watch that instead of linear, and that's driving that kind of alternate on. Matter of fact, you even saw Netflix just come out recently with that button where you say Just Watch because people are used to linear just turning it on, and they want to have the same experience. So they just want to hit Just Watch, right?

Right. From an infrastructure standpoint on the edge side, can you just talk about where you see yourselves positioned, not just in the OTT video side, but even talk about the edge opportunity, edge computing opportunity, et cetera, which Tom Layton talked about a decade ago? A lot of bottlenecks in the network back in that have been freed up and applications weren't really there, but it seems like we're there. And we're early, maybe, but we're still getting there. So just can you talk about that opportunity as well?

Yes. Sure. So the -- we've seen -- I think as companies want to break apart and move the logic that they're executing from being executed in one central location, they want to, what we're calling a logic charting, for lack of a better term, take my big blob of logic. And I want to break it apart into pieces, and I want to take the pieces that make sense, move them to the edge, the ones that are latency sensitive or that do data transactions that I need to have either localized for user experience reasons or potentially even for regulation reasons. So if I need to have a transaction that I'm executing in Germany and it has to stay there because of GDPR, I need to make sure that compute and the data can remain local resident and not have to traverse back to a cloud data center that's in the U.K. as an example. And so that kind of change of paradigm is really driving data to move from the center of the cloud out to the edge. And along with that data movement comes the compute because you want to compete to execute as close to the data as possible to stop having to traverse from the edge, meaning the edge in this case meaning end user, all the way back to some center of data, which gives you a couple of issues. One is you've got to pay for egress back out, right? So you've got a cost issue going all the way back. And again, you've got that user experience in terms of transaction. You want it to happen localized in real time for that user as fast as possible. And we see a number of things. We have to sell this with pandemic with things like getting in line for vaccines, where we needed to have localized experience. We're the local person, executing the compute needed to know the real-time status of the line that they were getting in for the vaccine. They couldn't go back to a cloud and wait. They wanted to get it in real time. And then when they signed up, you needed to know where you were in line in real time. And so that kind of data synchronization is really important to have at the edge. We see it with things like, I won't name the name, but large gaming console providers where they had limited stock, and they wanted people to be able to buy it. They needed to have waiting rooms where you could buy it but being held in real time and ensure they could manage that well, and that's also data and compute that needed to sit close to the end user. So there's a number of great use cases. There are A/B testing. Like we just talked about data localization, dynamic content assembly itself right at the edge of compiling a page itself and then what we talked about the logic charting, which is I think what we're going to see more and more over the next year or 2 years. I think Gartner says by 2025, 75% of data will move from the center of the cloud out to the edge, and I think that's the beginning of where we are today, and I think you're going to see that over the next 4 years.

And I guess so why is Akamai well positioned to take advantage of that market?

Yes. Well, I mean, the great part, as Tom did talk about it many years ago, I think we were ahead of the time. We did come out with edge computing Solutions because we had these servers, this real estate that's located super close to end users. And then -- and the cool thing about the Akamai platform that really differentiates us is that those servers that are delivering those images or that video or that game download is the same server and same code that's also inspecting the packets or inspecting the HTML or inspecting whatever it might be for security violation. So our last solution runs on that same server, our Page Integrity management. And then, guess what? That same server, we instantiate our Chrome V8 Engine that executes that same compute code, where it runs our EdgeKV, our key value store at the edge. So as we expand our platform closer to end users to deliver that great experience for video or gaming, you're getting the tangible benefit of expanding that edge for compute and for security all at the same time with no additional costs from an Akamai [ portal ]. We're doing it anyway to drive CDN, and then you get that for your compute. So it gives us that advantage that really nobody else has, and nobody else has that edge presence like we do.

And as we think about HBO Max is launching in Europe this summer outside of the U.S., you've seen a lot of growth internationally and your footprint -- have a big footprint internationally as well. So is there -- what's the opportunity there as you move outside and more OTT products get launched in foreign languages?

Yes. I mean well, again, all of our products, I think, get this opportunity. But when you think about OTT, the new markets, you got combination on the OTT platforms. You get new markets, South America, Europe, Asia, Southeast Asia as an example. The more nascent the market, the more opportunity there is. And whether it's HBO Max or Disney+ or any of the other platforms that are out there, Apple TV and so on and so forth, you're getting an opportunity to grow traffic that didn't exist before. So taking advantage of subs that were either on linear before in a market like Germany or in France and they move online. And we've seen that with other OTT platforms as they move, so you get a combination of new content that I think you're going to see an influx here as COVID -- as you come out of COVID, which will drive viewership even in the states and then new markets to your point. And that will drive OTT as well as gaming. And the great thing about those things, they drive our security solutions as well because as we sell to those same customers, they want to secure their platform, their API gateways that exist for log-ins that might -- that compute might exist in Europe. So as I'm logging in to HBM Max, I need to authenticate. That authentication platform needs security. Akamai is also located right there to provide security for their authentication system as well. So you kind of get all of those solutions all at once.

And could can you just talk a little bit about, on the edge side of the business, what competition looks like? It doesn't seem like there's as many companies out there that do what you do and do it to the extent in terms of geographic dispersion.

Yes. I mean I think our competitive advantage outside the states is still tremendous right now. U.S. is the most hypercompetitive market. It's got the most people that want to be in our space. And I think it has been that way for -- I've been an Akamai 17 years, and I'd say it's been that way ever since I started, whether it was years ago with Limelight and Level 3 or today, whether you want to call it Cloudflares and the Fastlys of the world. And they -- market has been the same, right? The competitors come in and easy to deliver in a market like the U.S. They offer low prices for, call them, E2 services that are not quite as good but maybe good enough and they try to get market share that way. And I think the issue for that is it's very difficult to scale that outside the states. It's still very difficult to scale that in the states, too, but definitely outside. So our geographical footprint outside the state gives us an advantage with enterprise customers in the U.S. because those enterprise customers, their customers, typically, a lot of them exist outside the U.S. So they will use Akamai to deliver in the U.S. to get access to our international footprint. They want to be able to deliver all over Europe, Southeast Asia, Northern Asia, Japan, Australia, and we're the only company in the competitive market that can do all those markets at scale, secure -- with security with the performance and quality that customers want, particularly in the enterprise space.

And just one last question on edge then we can talk about security a little bit. As you look at the revenue that you're getting on the edge side as you guys have delineated now, how much of it is usage-based versus more sort of monthly contractual revenue?

Yes. I mean that business over the years has migrated to less commit, much more usage base. And you win -- I mean particularly in the OTT space, you win with quality and reliability as opposed to I'm going to hold my customer hostage with the commit, right? In many cases, we do get commits to reserve capacity. But in terms of the lion's share of the revenue, it's mostly through usage.

Great. And so let's switch to the security side. The company, I guess, 8, 9 years ago now bought Prolexic, maybe not that long ago, but has basically grown that from $60 million in revenue to $1 billion over a fairly short time frame. How much did the legacy Akamai infrastructure play into the success of the growth within the security business? And then how do you think about sort of product development? You guys have -- there's been a number of products that come out, Bot Manager, et cetera, that have been introduced in the last 1 or 2 years that have grown pretty rapidly given this environment. And then just lastly on that is just the COVID impact on the security side, people working from home, a lot more attack vectors, bad guys doing bad things.

Yes. Let's see. I'm trying to remember all those questions at once, Jim. I'll try, correct, but you'll check me if I don't remember them all. But I'll start at the beginning, which is the Prolexic kind of what we saw there. And I think that -- I think that was 2014, if I remember right. I can't remember, but I think that's right. And what we saw there was a marriage of really 2 great things: one was Akamai had this great Layer 7 protection system so our WAF solution that existed in the application layer, and Prolexic had this great Layer 3 DDoS protection that a lot of people wanted to buy. And the 2 companies really brought together in providing the best in class of both together, and that's really what that merger provided for us. It was -- I don't remember the revenue size at the time, but I think somewhat equal in size, brought the 2 together, doubling -- becoming the market leader for sure. The great thing that Prolexic brought us that we didn't have, we had just begun, but we didn't have it in 2014 was our SOC. And we had started to build the SOC at Akamai, but Prolexic had, by far, the award-winning SOC that was out in the market, and that's now become a critical component of the security that we provide globally. So from the beginning of that, then adding on to that, we have invested a tremendous amount in R&D over the last years to build additional services, right? Our Kona solution, which is that WAF continues to get more capabilities on it. We built our Page Integrity management solution that protects those customers against third-party script invasion; our Bot Manager Solution that you mentioned; fraud protection; account takeover; credential fraud. All of those things are things we built organically. And then on the on the Prolexic side, that continues to be that Layer 3 kind of DDoS, where I can turn it on when I get attacked and have the SOC kind of mitigate, still continues to be an important product set for us and a great name brand that we've had in the marketplace. Let me see, Jim, I think you asked about COVID. I think...