Netflix is no threat to Akamai

Streaming movies don't mean much to sales or margins.

By InvestorPlace Jun 7, 2012 11:10AM

Image: Watching television (© Maria Teijeiro/Getty Images/Getty Images)By Dan Burrows

The selloff in shares of Akamai (AKAM) and other content delivery networks sure didn't last long.

After tanking Tuesday on the news that Netflix (NFLX) would build out its own service to boost the delivery of content over the Internet, shares came roaring back. Rivals Level 3 (LVLT) and Limelight Networks (LLNW) also suffered from knee-jerk selling and a whiplash rebound.

So what happened?

It didn't take long for the market to realize that the Netflix plan is all but immaterial to Akamai's competitve moat and bottom line.

Content delivery networks (CDNs) like Akamai make the Internet work better. They also are extremely complicated, capital-intensive affairs. Data centers located around the globe cache everything from URLs to media files to ensure the smooth delivery of live sports,  Zynga (ZNGA) games like Farmville and everything in between.

Now make no mistake: Netflix delivers a ton of data. At peak usage, it's estimated the company accounts for a third of all consumer bandwidth in the U.S. So with it's future tied to streaming movies and shows, Netflix's move to get into the CDN business makes some sense -- at least on the surface.

But that doesn't mean much to Akamai, as the market realized Wednesday. Analysts were quick to point out why Netflix is no threat to Akamai's business. Gary Powell, an analyst at Wells Fargo Securities, told clients in a note that the Netflix news is no more than a headline, and he's almost certainly right. Netflix, he figures, accounts for approximately -- wait for it -- 1.5% of Akamai's sales.

Add in the fact that the business Akamai and other CDNs get from Netflix is very low-margin, and it's clearly a business they can easily do without.

Besides, lest Netflix and its shareholders forget, building out a CDN is no easy task. Imagine starting a phone company or electric company from scratch. Not only are initial capital outlays large, but the costs are ongoing -- for maintenance, software development, monitoring and upgrades. Netflix says it will take five years to build its CDN, so any impact on the wider industry is a ways away.

Furthermore, it's those very same tech and infrastructure investments that give the existing CDNs fairly robust competitive moats. So rather than focus on the non-existent threat from Netflix, Akamai investors should take heart in the company's recent good news.

Akamai recently struck a deal to buy Cotendo -- a smaller Israeli CDN -- which helps sharpen Akamai's competitive edge, Trefis analysts note. The acquisition gives it access to Contendo's impressive client list, including AT&T (T), Facebook (FB) and Zynga, as well as the company's high-margin, value-added services.

Akamai's real challenge is to maintain its margins amid price-eroding competition from rival CDNs. Netflix's bold play in the content delivery business was a big one-day distraction. But it's hardly a threat.

As of this writing, Dan Burrows did not hold a position in any of the aforementioned securities.

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