Akamai could benefit from buying smaller rival
Increasing competition in its core business has forced the company to offer value-add services to augment its product portfolio and protect margins.
Cotendo, a smaller Israeli rival which competes with Akamai for value-added services, was founded in 2008 and launched in March of last year. The company has raised more than $36 million in funding from Sequoia Capital, Benchmark Capital and other investors, and also has the backing of strategic partners such as Citrix, Juniper (JNPR), Google (GOOG) and AT&T (T).
The private company has an impressive list of customers that use its site acceleration and application acceleration services, including some big names such as AT&T, Facebook and Zynga.
Akamai shares rose nearly 5% Wednesday to trade at $29 in the afternoon. Our price estimate for the stock is $31, about 7% higher than the market price.
Acquisition will help margins
Akamai had been the sole player in the content delivery market for many years beforeLimelight Networks (LLNW), InterNAP Network Services (INAP) and Level 3 (LVLT) started offering services at cheaper rates. Aggressive pricing saw prices decline in the Content Delivery Network (CDN) market, which has taken a toll on Akamai's margins. Its gross margins declined by a full percentage point this quarter, in spite of an increase in revenue.
Increasing competition in its core business has forced Akamai to diversify by offering value-add services to augment its product portfolio and protect margins. Akamai's value-added offerings have grown to account for almost 50% of the company's revenues in the absence of any other major player in the industry. (See Akamai Facing New Challenges in Value-Added Services.)
However, the emergence of new players in this rarefied market segment such as Cotendo threatened to pressure Akamai's margins, a roadblock Akamai hopes to eliminate with this acquisition.
That Akamai recognized the increasing threat from Cotendo became apparent after it sued Cotendo for patent infringement last year. It had sued competitors Digital Island and Speedera before going on to acquire them as well.
ARPU will also increase
Aside from decreasing pricing pressures, the acquisition would also allow Akamai to strengthen its value-added portfolio and help it gain share within the broader CDN market. Having a strong service portfolio to augment its core CDN business will allow it to price its combined services at higher price points and the company may see an increase in its average revenues per customer (ARPU) over time.
Cotendo priced its value-add services much cheaper than Akamai, but with a decrease in competition after the acquisition, Akamai may not want to renew Cotendo's existing contracts at those cheaper rates.
The deal will also help Akamai gain instant access to Cotendo's very impressive list of customers. The company managed to sign about 400 customers in fewer than 20 months since its launch, which is a testimony to its strong customer-centric service offering that could benefit Akamai in the event of a take over.
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