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

Excellent. Thank you, everyone, for joining us. My name is Keith Weiss. I run the software research group here at Morgan Stanley, and very pleased to have with us from Akamai, CFO, Ed McGowan. So before we get started, for important research disclosures, please see the Morgan Stanley Research disclosure website at www.morganstanley.com\researchdisclosures. If you have any questions, please reach out to your Morgan Stanley sales representative. So with that, thank you so much for joining us. We were just chatting.

You were here 2 years ago when we had last had this in-person. A lot's changed in the Akamai story in that time. I would say the knowable part is the security business continued to grow very well. You sustained a 25%-plus growth in overall security, and that's now representing 40% of the overall revenues at Akamai. The less predictable was the acquisition of Linode, which you guys just announced. A pretty major expansion in the capabilities of Akamai on a go-forward basis. So I wanted to start there because I think that's like a big new, new news at -- too many news, but big new news at Akamai on a go-forward basis. Why did getting into that part of the equation make sense, having an infrastructure-as-a-service cloud service provider, yourself, number one? And number two, why was Linode the right fit for you guys?

Yes. Great question. And Keith, great to see you, and thanks for having us out here. It's good to see everybody in-person again. Yes. So Linode is something that we've always talked about doing. Infrastructure-as-a-service makes sense for what we're doing, especially as you're seeing demand for more little latency use cases and that sort of thing. But this particular acquisition was informed by 2 things, really. Number one, it was informed by our customers. So our customers are starting to ask us for alternatives to third-party clouds, a lot of spend concentrated in 1 or 2, a lot of lock in. And getting more and more use cases for how can I leverage your platform as an alternative. You see there's an interesting blog post on our website where we talk about what we're doing with Apple and Apple Relay. It's a good example of a use case where a third-party cloud didn't quite offer exactly what they would be looking for. The second thing it was informed by was one of our fastest-growing expenses is third-party cloud, right? So now I just recently took over IT, and we've got about 50-or-so projects going on, a lot of which are being run in third-party cloud, and that spend is starting to become a pretty big issue. And we're embarking down the process of starting to move a lot of that in-house. And there's -- when it came to Linode, the challenge that I put on the table for Adam, who runs our Edge business was, see if you can find an acquisition candidate that can accelerate our capabilities in the space, somebody who's profitable. So basically impossible task to find something that's profitable and at a scale that made sense that could take a lot of the workloads that we have today and answer some of the questions that our customers are asking for because we bring some interesting synergies to the plate. So we happened to stumble across Linode, and actually some of our developers in the company were using them. And if you think about our compute business, which was growing, as we talked about last quarter, $200 million, growing at over 30%, we are primarily doing functions-as-a-service and starting to get into infrastructure-as-a-service. Apple is a good example. But there's other companies. I can't say exactly what we're doing for some of these other companies, but I wanted to find a more repeatable, scalable way of doing things. And there's a brilliance in the way Linode does things. Very simple to use, very easy to get up and running, where we tend to do -- solve very complicated problems with very complicated solutions. So it's hard to sort of take the typical way we do things and simplify it in that way. So we're able to add Linode to the fray. We pick up a business that's accretive immediately. We're making some significant investments. The challenge that they had as a company was very closely held. And anytime you make investments, you either have to decide you bring outside money in or making significant bets. So to support the enterprise, you need an enterprise sales force. You need to add capabilities and compliance functionality, things that we're already doing. So what to me was most interesting about this acquisition was informed by our customers and by our own needs, but also the synergies that we bring, the enterprise relationships, the backbone, our supply chain, our ability to distribute -- get distributed very quickly, very cheaply. So when you put that all together, it's made a lot of sense for us.

And just to dig into sort of the first point on sort of the customers are asking for it because of their bills with some of the big cloud service providers were getting high, your bills with the cloud service providers were getting high. Is the takeaway that this is a lower-cost solution? Or is it more on the perspective of there's unique capabilities that as a networking vendor, if you will, that Akamai could bring to the equation, and there are certain use cases within that, that you're going to be able to solve much more effectively than AWS or an Azure can solve?

Yes. So it's a little of both. And obviously, the capabilities are much greater than what you have with Linode, and I don't think we're going to ever go feature for feature. But there's a lot of applications that don't require all of that. And so that market is open to us. And then as I talked about, one of the things that we do well, we're in over 4,000 locations, we've got a pretty interesting economic advantage, right? I've got a massive backbone that I've built out over the years as we've scaled up. I can offer storage without egress fees, for example. I know that's a big pain point for customers. We even build products just to solve that problem. So I think it's a combination of both, Keith. It's going to be a little bit on, a little bit more inexpensive, and it's also an alternative. And keep in mind, a lot of these clouds have had issues over the years. And so looking at diversifying spend. And there's always new applications that are coming up. And I'm looking at building a bunch myself in IT.

Got it. Got it. So if we think about the -- like the market opportunity and prospective growth rate that we should expect from Linode, you paid $900 million, or you proposed to pay $900 million for the asset, hasn't closed quite yet. What was the revenue run rate that you paid for? What was the growth Linode was able to sort of garner themselves? We talked a little bit about sort of the go-to-market advantage that you bring, having the sales force already, having some of the scale. Where do you think Linode can grow on a go-forward basis?

Yes. Great question. So what I talked about on the call is they were growing at about 15%, but they're constraining their growth, right? So they weren't making significant investments. They weren't building out significant features, and they didn't have quite the access to the enterprise customer as we have. So we'll be doing that, and we think we can accelerate their growth. What was interesting is their larger customers are growing much faster, right? So there's an opportunity for us to obviously accelerate that. What I said on the call was we have about a $200 million business. We think we can get to $500 million or greater by 2023, which implies a 30-plus percent growth rate. And I think, obviously, the market is there. So clearly, it comes down to really an execution problem. But the way to think about it now is we have 2 very fast-growing businesses, compute and security.

Got it. So [ compute, yes, ] so and security is going to be a 20% plus grower on a go-forward basis as well. And then in terms of sort of the architecture and how we expect that to expand, you talked about the expansive network that Akamai has. I think that's kind of understating it. I think last time we talked about 365,000 servers, 1,350 networks around the world. Linode is not going to go into all of those. Like how should we think about how that sort of expands into your network? And does this significantly change the capital intensity of the business on a go-forward business?

Yes. So we're in about 4,000 locations. It wouldn't make sense to do the heavy compute that you can do on Linode in 4,000 locations. And I could see us getting to 50 to 100 locations pretty quickly. The good news for us is we've got relationships in place with a lot of these providers. We've got infrastructure in place in terms of our techs that go out and service our machines. So it's fairly easy for us to scale up. As far as the capital intensity question goes, if you remember on the call, I talked about the capital intensity of our business is going down, right? We were 13% to 14%, half of which is more software cap, the rest is more infrastructure. And I said that this year, Linode would add about 2 points. So it kind of gets you in that 15.5% at the midpoint, which has been kind of where we said the company would be sort of long term. We're forward investing this year with Linode in terms of building out more capacity in the locations that they have and also expanding the number of locations that they have. So I think -- and as I said on the call a couple of weeks ago that we think that we can operate the business in that sort of 15% to 16% range, including Linode, at least for the foreseeable future here. Because remember, the capital intensity is coming down as security continues to grow.

Right. Right. So this basically gets you back to kind of like what we were talking about 2, 3 years ago for overall Akamai offsetting some of the security gains. And then you said 50 to 100 locations. How many locations is Linode in today?

They're in about 11 locations today.

Okay. So that would be like a 5 to 10x expansion of their footprint. If we think about the -- I'm scarred by that last presentation. I just had to like race through the end of it. So now I'm like racing through this presentation. I got to take a pause here. When we think about the competitive environment for Linode, like the first thing this brings to my mind is like DigitalOcean as another easy-to-use, simplified infrastructure-as-a-service solution. It sounds like that's the competitive environment today, but you expect to expand it like, listen, we could go head-to-head with some of the big public cloud vendors that are targeting more of the enterprise with your kind of enterprise capabilities and being smart on what type of engagements and opportunities you guys go after.

Yes. Perfectly said. I mean I would have said that the best compare out there, public compare would be a DigitalOcean. The difference is this business was extremely profitable. Rare to see a business that could get to the scale and the type of profitability that they're at. And over time, as we add features and functionality that's informed by our enterprise customers, we will become more competitive. I don't think we'll be at the point where we're going to be able to compete for every workload. But you got to keep in mind, this market is so big and growing so fast that there is room for someone like us in this marketplace, and we believe we can do it.

Got it. Got it. I want to shift gears a little bit and hit on the security side of the equation. Security is now 40% of overall revenues. I think you guys hit that in 4Q '21, almost $1.5 billion run rate. Can you talk to us about how that splits out? Like is this all WAF and DDoS like the traditional products, have the new products really kicked in yet to sort of contribute a significant amount of revenues to that? And how durable should investors think about that growth on a go-forward basis?

Yes. Good question. So today, obviously, if you go back to our investor presentation, you'll see we broke out everything for you. I'm going to plan on doing another one coming up here in the next couple of months. DDoS, WAF are still the biggest contributors of growth, and they're still growing very, very fast. Now we're adding new functionalities to that. Bot management is also another part of the business on the web security side that's growing incredibly fast. We just launched a new product called Account Protector that we're getting some significant adoption of that. It takes a while for it to build. I mean at $1.5 billion in scale, it takes a while for things to become material. Same thing with Page Integrity Manager that we launched a couple of years ago. Seeing that grow very, very quickly. I think of that as a bolt-on of what you would have for WAF, so protecting all of your third-party content on your website. And we're also -- our enterprise business is starting to grow pretty quickly. much smaller in scale, but starting to get to be a fairly material number. And just with the Guardicore acquisition, the thing that I've been most impressed with is just the quality of the pipeline and the fact that the growth that we're seeing. First time we talked about Guardicore, we thought we'd do about $30 million to $35 million. On this last call, we updated our guidance to $50 million to $55 million. So we're starting to see some pretty significant adoption. Now keep in mind, with the threat landscape that's out there today, and I know a lot of people are talking about what's happening with Russia and whatnot, the conversations with our customers are picking up pretty dramatically, okay? I'm using you today, how am I using you in the right way? What other products should I be using? We all know something's coming. We don't know what it is, right? And we know at some point, there's going to be some threat vector. And I think we've got a lot of products and services that can help protect both on the IT side or kind of the enterprise side as well as on the website.

Got it. Got it. It's interesting that you bring that up. This is a little bit of aside from sort of where the conversation has been going. You are one of the few vendors that actually put in a Ukraine-Russia conflict risk into your most recent 10-Q.

We did.

So I mean, I want to say there's an opportunity on the security side of the equation. Is there on sort of the other maybe core CDN side of the equation, is that more of the risk?

Yes. So it's funny to mention we actually filed an 8-K today to just let everybody know what the potential risk would be, right? So we have very small business in Russia. We have a few customers. We've actually decided to move away from some state-owned entities. It's about 0.1% of our business or 1/10 of a percent. And then we also serve a lot of traffic into Russia, right? So we serve, think of all the U.S. companies, European companies, Asian companies that are delivering to consumers inside of Russia. We have not been told that we can no longer do that, but we clarify the risk, it's about 0.9% of our total revenue. So for some reason, the Russian government said no more delivery of traffic into the country, you're talking about an overall exposure of less than 1%. So I just wanted to give people the opportunity because obviously, international is growing really, really fast. And the last time we had anything where a government was involved was that you remember the China block where they blocked some applications from India -- actually it was India blocked some applications from China, and that was $15 million. This is obviously pretty immaterial. So we just wanted to get that in everybody's hands.

Perfect. Going back to sort of the security equation. From a go-to-market perspective, if you will, I think one of the things that we really liked from an investor perspective on like DDoS and Web Application Firewall or Page Integrity Monitor is you're selling into the same general customer, right? The guy who's running the website, he was the guy who was ensuring performance, making sure you don't have DDoS attack is part of ensuring that performance, making sure that people aren't swooping your website and having a Web Application Firewall, that's part of performance. So it was your existing core customer. Are you starting to see any sort of better kind of cross dissemination within the organization that's helping you get into more of the enterprise aspects of security as well?

Yes. So certainly, the biggest growth of our enterprise security business is with our existing customers and existing relationships. The other thing that we did part of the strategy around Guardicore was micro segmentation as a really good technology that every enterprise should adopt. No matter how good your defenses are, your Secure Web Gateway, your filtering and whatnot. People click on things, bad stuff gets in. And a lot of times, where you'll find it is it's spreading throughout your organization inside the network. So having what you call East-West protection, or watching traffic that flows across your network, is a good way to catch things. So what are the -- you go and you set up Guardicore, and you have the policies of where traffic should be flowing. So you can catch something that if you're financial system's talking to your HVAC system, there's probably some malware in your network. But part of going after that asset was there was no clear leader in that space, and recently, one of the analysts put us as the lead in that space. And we think that, that will actually help us bring along a lot of our other security products. So it was a way to expand our market, get to new customers and become the de facto leader in that part of the overall SASE framework.

Right. Got it. So I just want to drill into the Guardicore a little bit because it was a technology that was actually, I think [ on a lot of investors were at our screens ] where it should have been. It was a fast-growing micro segmentation. Can you talk to us a little bit about like, you said there's no clear winner in that space, but a lot of different vendors talk to us about micro segmentation. VMware was just up here just before you. NSX, that's one of the primary use cases. Who do you compete with in -- when it comes to Guardicore? Who does Guardicore compete with? And how should we think about that competitive set?

Yes. So great question. And actually, before we did the acquisition, the IT group was going through a vendor selection process. So we're actually going to be implementing Guardicore ourselves. And we picked it because it was we thought the best technology. And it's a pretty sophisticated integration, right, because you got to understand like what you have and what policies are allowed and whatnot. So it's a very sticky application. But the primary competitor there is another start-up called Illumio. So when we're competing Guardicore, it's primarily with Illumio. I know a lot of the other vendors are starting to get pieces. But traditionally, in our head-to-head battles, we don't see a lot of other providers. It's been pretty much Guardicore and Illumio as the 2. And like I said, we thought that was the best technology, not only from an acquisitions perspective but also from an IT perspective.

Got it. I'm going to tread on thin ice here, a little bit asking a CFO a product question.

Oh, boy.

But when it comes to Guardicore in particular, but more so micro segmentation, you talked about Illumio, I brought up NSX before, the micro segmentation solution. There have been prior generations of sort of micro segmentation solutions that haven't gotten scale, right? Haven't gotten to that critical mass, and it's kind of broken [ free ] and become a leader in the space. And we've been talking about micro segmentation for 6, 7 years now. Why do you think that is? Like what's been the difficulty in what seems like such a obvious solution of that, hey, listen, you got to stop that East-West traffic, you got to stop the proliferation of these threats once it gets inside your organization? Segmentation just seems like a very obvious solution. Why has it been so hard to get that technology to take hold?

Yes. I mean, first of all, it's a lift. It takes time. It's a hard thing to do. And a lot of the technologies that were out there before weren't that easy to use. And Guardicore is a fairly easy-to-use technology. So I think the advancement of the technology, and I think the Guardicore team has done a phenomenal job, and you've seen just those 2 data points I gave you about our -- where we thought the company was when we bought it to where we are now, you're seeing very, very fast growth in that area. And the other thing, I think it's just the overall threat environment and landscape has exploded, especially with COVID. And so what people are finding is those traditional services and solutions, no matter how good it is, you do have vulnerabilities. And this is like another thing that in terms of hygiene that all companies should be doing. So I think it's really a combination of new technology that's better, easier to use, easier to implement along with just the explosion of threats.

Got it. Got it. Two more questions on security, then we'll move on to the rest of the business. In terms of sort of bundling and penetration, you guys have a pretty broad spectrum of solutions now, both in terms of more of the web security products but also on the enterprise side of the equation. Can you remind us where you are in terms of within your current installed base, how penetrated have the security products become, number one? And number two, how much more kind of wallet is there to go after. You're at 30% of your customers are taking on security products, and they're taking on 20% of the portfolio, like how should we think about that latent opportunity with...

Yes. Great question. So first, I'd say our new customer acquisition has been primarily security led. So we're adding new customers all the time. We've got about 2/3 of our customers today will take a security product, and we've got about 1/3 that are taking 2 or more. So we break that out every quarter, usually somebody will ask me that on a call. In terms of wallet share, what's interesting is it's multifaceted, right? It's -- if you're a Kona customer, for example, Kona meaning our WAFs product, you may have it on your primary site, but you may have 200 applications. So there's a chance to expand within the customer base. So if you're -- it's not a won and done, like I say, if Morgan Stanley is a customer, you might be -- your primary site is using it, but your wealth management site or your trading sites, et cetera, no reason why you wouldn't roll that out. So there's a chance to get in and expand that way. But then you're adding on other functionality, bot management, Page Integrity, Account Protector, et cetera. So we're doing a good job. And if you look at the growth rates, and I don't remember off the top of my head, but we'll break it out for you when we get together in a couple of months. We are seeing customers buying 3, 4, 5 security products, and there's a lot more room to go in the installed base for sure.

Got it. And then last one on the security side of the equation. M&A has been a significant component of building up that solution suite over time. How should we think about that on a go-forward basis? Similar kind of M&A appetite on a go-forward basis, maybe wedded by the fact that valuation is actually going down a little bit now? Or is the suite more kind of functionally complete, and we'll see less of that going forward?

Yes. I think we talked about in our Analyst Day last year, M&A is part of our strategy. And we're approaching $4 billion in sales, and you're at a scale that it's hard to build something from scratch and scale it. Buy something that's subscale, getting to scale like Guardicore, scale it up, it's much faster to get the type of revenue growth that we'd like to see. We are pretty disciplined buyers, although we've been very active over the last 6 months, buying 2 fairly large companies. But yes, I'd say M&A will continue to be part of the strategy for sure, absolutely.

Got it. I do want to take a pause if there's any questions from the audience before I go on. I get in trouble if I don't do that.

Can you please walk through the cross-sell ability between core CDN and Linode? I'm just trying to understand the rationale for a CDN customer to become a customer of Linode and what the pitch would be. That's my first question.

Yes. So let's say, I'll pick a media company, right? So a media company today might be using us for delivering streaming, right? But think about their workflow applications, their transcoding or their content management system, et cetera. There's no reason they couldn't run that on Linode, right? So as a diversity of supplier, as a backup system, as a primary system, a customer in CDN, let's say, has content that's stored in a third-party cloud that has got a lot of, call it, cold content, right, that's being accessed by CDN or by some other -- by users doing something else. You could move that to Linode and save on egress fees example. A gaming company today. So we could do, say, today with functions-as-a-service, we could assign someone to a game dynamically at the edge, but now you have the capability of actually building the whole game inside of Linode. So I think there's a lot of cross-sell opportunities. These are just a few examples that I could come up with off the top of my head.

And then secondly, on Linode. Can you walk through the client exposure, meaning SMB versus enterprise, the percentage of customers, perhaps some metrics on churn and what your vision is over the next few years in terms of changing the dynamics there?

Yes. So great question. We haven't broken out a lot. So I'll just tell you what we've talked about. There's about 150,000 customers. We haven't broken out the churn rate. They've done a nice job of growing that customer base. We'll continue to grow that customer base. I think what the big scale that we can bring is the enterprise customer base. The other thing we can do is offer solutions to some of those small customers that they don't have today. So it could be a good example. Today, they offer a basic WAF so we can obviously make that better. But they also -- we offer security services, like say, for example, DNS filtering, right? So filtering out bad domains. We can do that very easily. We do that today at scale with some of our carrier partners. There's no reason why we couldn't do that. Today, we have -- if you go to the Azure store, you can actually buy basic CDN functionality, but Linode doesn't have that. So there's the ability to grow that customer base with additional functionality. But I think the really -- the biggest opportunity from a revenue perspective is getting to the enterprise customer, but also getting to some of the verticals that you don't traditionally see as large CDN customers, right? So think about like life sciences, pharmaceutical, natural resources. Those typically aren't big CDN customers, but it just opens up a whole new market for us. So I think the division is to continue to grow what they have, add enterprise customers, add functionality and look for ways of selling scalable solutions to the entire base.

We had a question up here?

Right. Just want to double-click on Linode there for a second. Just given that historically, it's just been such hyper-focused shop on the SMB and developer space. And a lot of people come to Linode because they're like, hey, there's not another independent player out there, especially now with DigitalOcean going public. Do you see any risk in being able to continue to service that segment of the customer base and continue to grow that as you kind of shift focus to enterprise? And I guess on top of that, when you think about layering kind of the sales and marketing and go-to-market for enterprise from Akamai back on to Linode, do you see any kind of big risk there of actually being able to execute on that front?

Yes. So it's a really good question. It's something that we're taking an interesting approach to, which is we want to leave what they have intact. This isn't an acquisition where we're saying, okay, the cost synergies, we're going to eliminate redundancy in this and that or dump what they're doing. We think what they did is brilliant, right? There's a brilliance in the simplicity of what they do and how they've done it and make it available for people. And that developer community is big. As a matter of fact, a lot of our engineers today have built applications on them, right? That's how we originally found out about them. So we want to maintain that. So we're going to move some senior leadership from Akamai into Linode. We're going to treat Linode as almost like Akamai is a channel of Linode, right, so that we don't break what they have because there's a lot of great things that they've done. And what we bring to them is the ability to make the investments to increase the value for all of those customers with some of the things I just talked about, right? So we're going to be adding things that our enterprise customers will be looking for, but the small customer can benefit from it as well.

One last one in. We're running over time.

Oh, sorry about that. I guess it's good, [ at least the ] alternative, right?

I guess just a quick follow-up on Linode. In the existing Linode use cases today, how much of those are sort of migration from a traditional cloud to, say, them, how much of them are just building new applications from the ground up?

Yes, it's a good question. I don't have the exact numbers. I would say it really depends on the lock-in and what you're doing with the third-party cloud. So I'll give you an example. I have an application that we're running internally, and I asked the question, "How quickly can we move it?" And they said, "Well, I actually built it on a third-party cloud and didn't use a lot of features." So that's something I could move very quickly. I think new use cases is the easiest to do, obviously, because you're not going from something to something else. It depends on what type of application it is and how disruptive it is. So it's not necessarily dependent on things moving from A to B. It's also opportunity to have new use cases as well.

So that actually takes us to the end of our time. Any last thoughts you want to leave us with?

No, just thanks. It's great to see everybody, and hopefully, go out there and execute and just get the second exciting growth engine going.

Excellent. Thank you very much. Thank you for joining us. Thanks.