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

All right. Good morning. Thanks, everybody, for being here. My name is Frank Louthan, I'm the senior analyst here covering telecom, CDNs, cable, all bunch of other stuff. I'm very glad to have Akamai back with us again. We've got Ed McGowan, CFO of Akamai, here for the presentation. So Ed, why don't we start out just kind of level set a little bit, tell us about Akamai, what you do, how you fit into the space and the business you're in, to kind of start there, and then we'll jump into some questions.

Sound good. Can everybody hear me? Thanks, Frank, for having me here. So yes, Akamai has been around for 25 years. We pioneered the CDN business back in 1999. We've changed a lot over time. We now have a $2 billion security business and about $0.5 billion compute business. So we are -- have 3 different businesses, CDN, which is our legacy business, compute and security, and the company is very, very profitable. We're approaching $4 billion in sales. We got about 30% operating margins, very attractive free cash flow. And that's pretty much at a high level where we are.

All right. Great. So you talk about the delivery business and we'll get into some of the others. But tell us a bit about your network that's kind of a base of a lot of what you do, get a lot of questions from investors about newer networks built on SDN technology. What are some of the advantage to your network? And how long and what would it cost to replicate that? Is that even possible?

Yes, good question. It's funny. There's -- I've been hearing this for years, actually, even going back to when we first started Akamai as a legacy network. And the term SDN, we were doing software-defined networking before it was even a term. So our whole -- if you think about our platform, we do multiple things on our platform. So we have machines that are in 4,000 locations around the world, probably the most distributed platform or one of the most distributed platforms in the world. And those machines do multiple things. They deliver content for our customers, they serve video, they serve uncacheable shopping content or banking transactions. They do security processing. So for example, I might be serving a web page to you and at the same time, I'm applying web application firewall rules. So I'm doing security processing at the same time from the same machine, by the way. I think there's a misnomer that we have a whole sub series of networks that we have. We'll talk about our network in different subsets, but it's all the software can run all of our products. There's one exception, which is our Prolexic network, which was a denial of service at the IP layer, which essentially think about that as scrubbing centers that are separate. And then obviously, Linode is a separate company that we bought a couple of years ago. But I think it's -- people misunderstand and think that we have -- each one of our products runs on a separate network, separate servers in all of these locations. That's just not true. Now in terms of your question around how difficult is it to replicate, I think if you just look at even just CDN, for example, we've had a lot of competitors over the years not make it. And I think the biggest challenge is economics. I'd say the economics is the hardest thing for someone to replicate. Today, we have 70%, 80% of our traffic is free, and it's because of 2 things. One, we have relationships with a lot of these ISPs where by having our content servers in their networks, we save them a tremendous amount of money by having the content stored locally. A lot of the traffic that we do serve is cacheable traffic. So not having to go backhaul that traffic or build peering links saves them a lot of money. So we get favorable economics in return. And also, several years ago, we spent a lot of money to build out a backbone. So we've got a sunk cost in our backbone. So we don't have a lot of transit costs or anything like that. So I'd say economics is the hardest thing. And then just building those relationships, getting as distributed as we are is very difficult where a lot of folks that build distributed platforms today might be in a dozen locations in really the congested part of the Internet and the core data centers, which is okay for some amount of traffic, but at some point, it becomes challenging, it's more costly and also you have performance challenges, especially on days where you've got a lot of congestion on the Internet.

All right. Great. That's helpful. So let's talk the newest part of your business, compute platform. Let's talk about that a little bit. It's pretty well integrated in your business. How has that changed your go-to-market strategy and how you're approaching customers and what products do you lead with compute?

Yes. Great question. So we're making several changes this year to go to market. If you think about last year, we spent a lot of time doing 2 things. One, we spent a lot of money building out another 13 core data centers. We have about 25 core data centers. This year, we'll be building out 100 distributed sites which are much smaller, not as much CapEx. So there's a lot of build and there's also a lot of innovation that was going on in compliance and getting the platform that we bought from Linode, which is really focused mostly on small and medium business, although it did have some enterprise customers, getting it ready to take on enterprise workloads. So connecting it to our backbone, building up more capacity, adding more compliance functionality and things like that to be compliant with things like PCI, et cetera. So now that we've done that, we have from a go-to-market perspective, we now have changed our compensation plans and all of our reps have to sell compute. If they don't sell compute, they don't hit accelerators. They don't get to Titans club. That's what our President's Club. And I can tell you from running the field, I used to run sales before I came into be CFO, that will have a dramatic impact on the amount of deals that we see. Now in terms of what products do we lead with, it really depends. I was on a sales call the other day. We were going through a renewal and this expression is so easy a CFO can sell it. So I said I want to go see if I can get a compute sales cycle here. So going through with a big customer, a very large customer, probably spends $4 million, $5 million a year with us and they're going through cost cutting. And I said, okay, well, we can negotiate our deal, maybe you save 10%, 15%, whatever. It's not going to make a dent. How much do you spend on egress? Just I know you use your application is hosted at one of the major clouds. So I bet you spend more on egress than you spend on your entire CDN business. Yes, a good point. But we can eliminate that cost for you. And by the way, we can also help you with performance if you're in, say, in the advertising space, you could run your advertising decisioning in 100 locations closer to where the user is, it's more cost effective and it's a lot lower latency. Sure enough, we have a sales cycle now open with that customer. So it's very easy for us to take what we're doing for customers today and open up an opportunity. Think about media, for example. We do a lot of work with social media companies. When you're doing things like live transcoding or uplink and encoding, doing that close to where the user is and getting that content loaded cost effectively and monetizable as fast as you can, makes a lot of sense, right? And that's something that we're already talking to them about performance of their application, scaling the delivery, going into how they actually prepare the content and put it up on the network, how they store it, very natural for our sales reps to sell, so easy a CFO could even sell it.

That's great. So one of the questions we get from investors is how do you compete with some of the larger compute platforms. Maybe walk us through what's a typical type of product and things like that and how you compete with them and what your advantage is versus the larger ones?

Yes. So I mean if you think about the world is moving more towards a multi-cloud architecture. And it's not like we -- it's a zero-sum binary game where we win and someone else loses. There's opportunity for a lot of cloud providers to win. I mean, just look at the market today, it's dominated by 3 players, but massive market, growing very, very rapidly. And there is a -- we actually sort of got pushed into this market by our customers, by some really large customers that came to us and said, "We think that your platform, you have a unique advantage over what the current hyperscalers provide today." There's some interesting use cases on our website, one in particular is with Apple, where they were doing a private relay. And if you think about that to work, you can't have everything hauled back to a dozen or 2 dozen locations. You have millions of users all over the world. You need to run that application out on a distributed platform. We have several other customers that were asking us very similar things for say, video or advertising. And so we realized that there is a niche here for us to potentially create a pretty interesting business. Also, there's -- we found ourselves that the fastest-growing line in our P&L was our cloud spend. You might say, wait a minute, why would you have cloud spend? Well, we're obviously being a security company we see massive amounts of data. And when you have a lot of the data, just think of almost like how you think about training AI versus inference engines, you wouldn't have all that data out on the edge. What you want to do is take all that data into a central location, process that data, come up with rule sets, make your software a lot smarter that when you're out on the edge, you're doing a lot lighter weight compute. So we were using hyperscalers for some of our data collection and processing, and it was costing us a fortune. So we decided to move all of that internal and we became sort of customer one, our first $100 million customer is ourself. What we realized is that we could do it a lot more cost effectively. One of the big pain points we see with customers is, I talked earlier about egress. And what egress is if you store data in a central cloud and you access that data, the data moves around a lot. It's accessed frequently, it can cost you a fortune. Very cheap to store, very hard and expensive to access. We serve hundreds of terabits per second of traffic across our network today. We've got one of the largest backbones in the world. So our cost to add that traffic is virtually nothing. So that's a competitive advantage for us to go in and take some of that business and say, look, you could put that on us. That being accessed frequently, it's not going to cost you anything. So there's a cost advantage, there's a scale advantage, a performance advantage. Being the most distributed cloud, we think has some pretty interesting applications for us.

All right. Great. So on the call, you talked about this new Gecko product that you have. How are you building that out? And what sort of solutions does that offer or going to offer when it gets fully pushed out that you don't already have?

Yes. So Gecko or generalized edge compute, I think I said it right, but anyway, is going to be -- think of that as being in today, 100 locations, probably in some of our larger CDN locations where we already have space power and favorable economics. We've got our CDN infrastructure already there. And there, you're building out several racks of equipment with the Linode technology so that if someone wanted to run full stack applications, they can run it in over 100 locations today, leveraging us. And that could be for things like advertising, for encoding, transcoding, for banking transactions that have low latency requirements. It could be just you want to have something running in a location where one of the hyperscalers don't offer that location. It might be a small country somewhere, and we happen to have a deployment there. And you'd like to have it localized, maybe there's a data localization issue where you need to keep that data local, and we're the only option in that particular country. AI inferencing could be run in a situation like that where you use your training models in the hyperscaler, but you're running a much lighter weight AI decisioning engine out where things are being processed, maybe where video is being served or ads being served, et cetera. So a lot of different use cases for that. And actually, that was some of the early push from our customers. We sort of did this on a custom basis where we built out and ran custom code in hundreds of locations across our network. So we've seen demand for this early, early on, and I think there's a lot more interesting applications in the future.

All right. So now that we're not going to disappoint anyone searching on the term AI in the transcript. Let's maybe talk a little bit about the breadth of your network in an AI world and how you can benefit from that and your customers.

Sure. So we think it's AI in 3 ways. One is obviously, as a company, the productivity gains you can get from it. Today, we're using AI in our security products. So we've been doing that for years. In terms of the last cases as a customer, so could customers use us. We do support GPU today. I don't envision us being a source where people will be doing large training models. It just doesn't make sense. We're not going to go make that investment to go build out for massive training models. But for inference engines, you can do that. You can actually do that, and we're doing it today. We're using CPU and really sophisticated algorithms. You could run GPU out there, and we can certainly do that. Our platform supports it. If a customer wants us to do that, we could do it. But I'd say, from a customer perspective, that's probably the most interesting area for us is on the inference side.

Great. So put this in as numbers. So walk us through kind of what it takes to achieve the high end of your '24 guidance and what might cause you be at the lower end of that range.

Yes. So there's a lot of things going on. I'll start with the delivery business. So we had probably -- I think people would say somewhat disappointing guidance around delivery. We saw traffic growing fairly nicely going into Q4. Q4 is a little bit weaker than we normally see in Q4. So we'll start to see Internet traffic slow a little bit. We have 7 of our largest customers renewing and in the delivery business, we talk about our largest customers being greater than 1%. Our delivery business is less than half. So you can imagine those customers are fairly large delivery customers, so they have an outsized impact. Those are all renewing in the first half of the year. So the outcome of those renewals, if they're better than expected, that can help us get towards the top end. If we see better traffic growth than what we're seeing now, that obviously has a big impact on the top line, but also on the bottom line, probably more so on the bottom line, we're very levered towards quick growth in traffic, user yields, great benefits on the bottom line. Security. We talked about 14% to 16% for this year is our expectation. We don't plan on any headline-grabbing events to drive upside in revenue. We've seen it over the last few years. We've seen even things like our legacy Prolexic business will get a boost sometimes from things like the KillNet attacks that hit the health care industry a couple of years ago. So there's always an opportunity for that to happen. Compute, it's a newer business for us. We've got, obviously, a big pipeline. We've got some pretty big, exciting opportunities in that pipeline, the timing of those, the size of those obviously can help drive upside as well. Obviously, when you put guidance together, you have to be very balanced in your approach and looking at all the different things. But those would be the main things that would drive us to the upside.

All right. Great. So on the distribution side, we always get the question about self-provisioning and some of your larger customers kind of doing it themselves. How do you remain relevant in a media and cloud world where you've got a lot of those customers that are building some of that themselves? And how should we think about your -- how you can continue to be relevant there?

So if you go back to like the 2014, '15 time frame, the DIY phase, if you will, or craze was something that -- so it took the whole industry by surprise. So that slowed growth pretty significantly in the delivery business back then. We've seen that cool off quite a bit. As a matter of fact, there's some large customers who were heading...

Now it's hard to do.

Well, it's hard to do, and it's expensive. That's the other thing. We've seen some large customers head down that path. And obviously, the ones that have their big platforms, the Facebooks of the world, they're not going to tear them out. But there's some others that were talking about going in this direction have now reversed course. It is expensive. Labor costs never go down, they only go up. You can drive bandwidth costs down to a certain point. And I think what -- if you see -- if you look at high-volume traffic today in the industry, it's a lot cheaper to go with a third-party CDN. And it's not as much of a strategic value, I would say, at this point. Maybe early on when telcos had a little bit more of a pricing power in the market. That sort of has gone away. So I don't really see that being a threat. Obviously, with some of the big largest platforms in the world, they can take on more themselves. But we find actually them giving us more because we're more cost effective.

So there's been an expectation maybe that delivery business would flatten out? What's sort of your expectation on the trajectory of that business?

Good question. We've sort of talked years ago, about 2 years ago, now 3 years ago, whatever it was, that we thought this business would be flat to down 4%. We've been surprised a little bit to the downside where we didn't get the traffic growth that we expected. Traffic on the Internet has usually grown about 30% year-over-year. We aren't seeing that anymore. During the pandemic, you saw it double. The year after the pandemic, its like 2020 or 2021, very strong traffic growth, then all of a sudden, it really moderated and is much below trend line. So that's something that, if I were to look back in my models, I would have expected us to have higher traffic. So that was probably the biggest thing. Then I'd say just the big renewals, if could say, well, how would you get to negative 4%, it's when you have large customers renewing, and you assume that every couple of years, you're going to have that happen. So those are the sort of 2 factors. So it's really the lack of traffic growth is what's really causing us to have lower than sort of expected downside in the delivery business. So as soon as we see traffic increase, you've got -- like I said, you're very levered to having a good outcome. We have the capacity and we have the infrastructure that a lot of that will just drop to the bottom line. But I don't expect that business to be flat or growing certainly this year and probably not next year. It's hard to tell at this point. I am not going to go and put a projection out there on what I think is going to happen next year, but we'll have to see a pretty big change in the just Internet traffic in general for us to get on a path where it's sort of flat to growing again.

Right. And how do you see that in overseas markets versus the U.S.? What kind of drives that non-U.S. business as far as applications or security or what is it? And how should we think about those 2 parts of your business?

Yes, it's interesting. Obviously, from the delivery business, most of the content is still U.S. content, the biggest gaming companies, the biggest production content is still U.S. So in terms of the international business, if you think about it from a market share perspective, we tend to get more market share from those customers delivering outside the U.S. In terms of security, I'd say it's pretty much an even playing field. The attackers don't pick one country or another. They're attacking everywhere. So we're seeing good growth pretty much across the globe. It's interesting. We are seeing a pretty good pickup of business in Asia with our compute business. So early adopters in Asia, which is pretty interesting. I wouldn't have expected that. I'd say we've got sort of an advantage over our traditional customers in that we invested in that infrastructure in terms of our people and the infrastructure you need to run your business outside the U.S. well ahead of folks. And it's difficult, it's expensive, it's hard to do. We've been able to do it. It's been the fastest-growing part of our business for many years, and I think there's still a lot of opportunity there.

All right. On the security side, so when you win with security, who are you competing with? And what are customers giving? Why are you winning over the competition in that business?

Yes. So I think about our security in sort of 2 different businesses. There's the web security, so protecting websites, web applications. And there, we're the market leader when it comes to things like web application firewall and then you're really competing against sort of the traditional way of doing things, doing something with a box and having a box in a data center that's providing your firewall. That business, we do see some competition. They generally try to compete on price. In the security market, competing on price isn't usually a successful endeavor. It's really about capabilities, expertise and switching actually bring some risk to the people that make a decision to switch. If you get attacked after you've made a switch and somebody exploits the vulnerabilities from, say, from a competitor that doesn't have the type of protections, you can open yourself up to potentially some very unfavorable outcomes from either you lose your job or you get sued or whatever. So we don't see a lot of that on our -- within the web security business, web app firewall, which is the biggest. There's bot management, which is sort of a new space that we sort of pioneered, which is understanding that a lot of the traffic on the Internet today isn't human, it's machine, so understanding what machine is interacting with your website. What do you do with it? How do you -- should you block it? Should you give it wrong information? If it's price scraping bot, that sort of stuff. There are smaller competitors out there that have tried to catch up to us, but we're sort of a market leader in that space. API security is a newer security area. There's a couple of start-ups that are in that space. That's a huge opportunity where you think about modern applications today, everything uses APIs. There's a tremendous amount of attacks that are going on right now with open API gateways, and there's not a lot of good solutions. So I think we could be a market leader there. On the enterprise security side, where our strength is micro segmentation in access. So think of replacing a VPN with our remote access product. And with segmentation, there's one startup that we've sort of leapfrogged since we bought, Guardicore. But there, you're sort of -- what's interesting is with segmentation, people generally think about segmentation as something that's very difficult to do. We've actually been able to do it pretty easily with our software agents and think about that as having a firewall basically on every application and being able to segment your network and be able to identify threats as they get in. And there's an interesting story about one of our competitors have talked about vendor fatigue and vendors getting upset about spending all this money, but stuff still gets in. Well, that's a perfect opportunity to use segmentation because what segmentation will do is identify something that gets in and block it and stop it from spreading. So no matter how good your endpoint security is, your filtering, whatever, stuff still gets in, and this is a great way for you to be able to identify things that are in, block it, stop the spread and limit the damage.

All right. So what have we seen with pricing in security? I think a major pure-play security company adjust -- lowered some pricing. How do you see that holding up in your business and the outlook for the year for security pricing?

We haven't seen pricing pressure in security. We've seen some competitors try to compete on price. Sometimes, you've got good relationships with your customers. They'll show you some desperate attempts of somebody saying, "Hey, I'll do it for half the price or 1/3 of the price." And generally, that's a warning sign. If you're in security, you generally don't want to answer that call. But we haven't seen the pricing pressure there. Is it possible over time? Sure. It's technology. So over time, it could creep into the business, but we have not seen it.

Great. I'm going to see if we've got any questions from the audience, might have a couple in the morning. All right, great. So all right, so why don't we talk about how should we think about uses of cash here and how do we think about buybacks, debt repayment, that sort of thing?

Yes. So we've been -- we're producing a tremendous amount of cash. Our free cash flow is going to be up pretty significantly this year as our CapEx is down. We did a major build for compute last year. Our policy is to, from a buyback perspective, is to offset dilution from our equity plans. But if you look over the last 5 to 10 years, we've reduced our share count by about 1%, a little over 1% a year. That's not our stated objective, but we are opportunistic with our buyback program, and we traditionally have been retiring about 1% or so of our outstanding shares. The best use of cash for us is through M&A. That's the preferred use of cash if we can do it. Obviously, we're reinvesting back in the business, but we're free cash flow positive. So it's really a combination of M&A and buybacks in terms of use of capital outside of investing in the business.

So on M&A, so what have you seen in the M&A market? It's been interesting observation here at this conference, we have the most corporate attendees we've ever had. And as an analyst that has done this more years than I want to admit, this -- I think it's M&A. There's been just a lack of it, a lot less of it. And a lot of talk to some of my peers. We're not getting the calls about a scheduling conflict a couple of weeks out and that sort of thing. So what do you see in the M&A market, have interest rates helped or hurt that? Do you see opportunities in M&A more or less? How should we characterize it?

Yes. I mean, obviously, there's -- from a big M&A perspective, you've got an administration that's anti M&A. So we're not seeing the big deals anymore. But from the -- it's interesting, if you go back a few years ago with interest rates near 0, every company that was private thought they were worth a fortune, right? Everything is in the terminal year and you got crazy valuations. You would think that those would have corrected. And you've got a lot of disciplined buyers like ourselves. We can't go out and afford to pay 100x revenue for a company or anything like that. You would think that, that would start to correct. What we're seeing is a lot of companies back in 2001, raised a lot of capital -- sorry, 2021 raised a lot of capital. That's starting to dry up. And we're hearing from a lot of companies, hey, we're either looking at a down round or potentially exploring M&A. So starting to see a little bit more activity, but you still have stubbornly high valuations, especially in security. So I think you're going to see folks like us and other companies in the space that have cash that are going to be a lot more disciplined and patient.

Okay. Great. And any other -- any questions from the audience? All right, no. All right. So you know I'm going to ask the dividend question. Where are we on that? What are the right parameters for you to consider a dividend and how far away are we from maybe making that decision? You've obviously got a lot of cash. You used it well. You're doing the buybacks, but what's that sort of the next step? How should we think about that?

I mean I think there's -- obviously, the markets we're in, security and compute in particular, just massive opportunities. And I think we see a lot of growth opportunities ahead of us and the best use of cash being M&A to accelerate our opportunities in those spaces. It's something that we talk about with the Board and we explore. I think there's always been a stigmatism around dividends that in the tech if you're paying a dividend, you have nothing better to do. Starting to see that change a little bit. You see some big tech companies starting to announce dividends. So it's something we'll think about. Obviously, we do have the profile to be able to pay it. We certainly produce a lot of free cash flow and we could certainly do something like that. But it's once you initiate it, you can't take it away, people want you to grow it. So it is something you have to really think about and think about your shareholders, what do they want? They want -- a lot of our shareholders want to see us grow and you don't want to paint yourself in a corner and not have the capital to be able to grow. So it's, again, something we think about. We certainly have a profile to do it maybe someday. But right now, we're not -- it's not there for us.

Okay. And on the preferences on M&A, is it more security? Is it more doing the compute? You did take in a couple of orphan delivery guys last year, but maybe there's more opportunities there. But what are your thoughts on the longer-term growth of the business?

I'd say it's kind of more of the same what we've done. Opportunistically, if something presents itself and it makes sense from a scale perspective, we always look at those. Those -- you can't count on those. If they come up, they come up, you evaluate them, you do it if it makes sense. On the tech tuck-in side, you'll probably see us do a bunch of those. We've done those over the years. Acquiring talent, sort of accelerating your road map, maybe getting some technology going to bolt into something. And we've had a pretty good track record with that. Adjacencies and security is an area that we've done and we've been pretty successful, especially with Guardicore. So we'll look to do stuff like that. I don't see anything transformative. I don't think we are in a position where we need to do something transformative. So I think it would be kind of more of the same of what you've seen over the years of what we'll be doing.

Okay. Great. All right. Ed, thank you very much. We've got a breakout session after this if anyone wants to continue the conversation.

Thank you very much. Bye.

Thanks. And appreciate it.