05/23/13 05:00:04 PM TECH KNOWLEDGE

SECTORS: DETAILS ON OUR VALUATION-DRIVEN DOWNGRADE OF AKAMAI

After recent significant appreciation, we downgraded shares of Akamai Technologies (AKAM 48 ***) to hold from buy, based largely on valuation. We see AKAM as well positioned and poised to benefit from a number of important trends, but view the stock as fully valued. We also note some important risks to consider.

Shares of Akamai Technologies performed well of late. Year to date through May 17, the stock appreciated 16%, in line with the 17% increase in the S&P 500. However, the shares notably underperformed the average gain of 27% of the Internet stocks within our coverage universe. Nonetheless, since April 19, when the stock closed at a recent low, the shares rose 42%, compared with increases of 7% in the S&P 500 and the 13% average for the Internet stocks we cover. We think AKAM shares were somewhat adversely affected by its analyst meeting held on March 11, where some might have been disappointed by its indicated outlook and confused by its reporting updates. The shares are now within about 4% of our 12-month target price of $50.

We view AKAM's fundamentals as strong. We project revenues of $1.556 billion for 2013, $1.774 billion for 2014, and $2.022 billion for 2015. This implies annual increases of 13%-14%, without adjusting for the January 2012 sale of the Advertising Decision Solutions business. The Capital IQ consensus estimates are for revenues of $1.547 for 2013, $1.755 billion for 2014, and $1.993 billion for 2015. As indicated, our forecasts are around 1% higher than the Street projections. We forecast EPS of $1.59 for 2013, $1.85 for 2014, and $2.10 for 2015. The comparable Capital IQ consensus estimates are for EPS of $1.45 for 2013, $1.68 for 2014, and $2.03 for 2015. Our projections are 3%-10% higher than the Street consensus. We believe that new products, new partnerships, and new salespeople and support staff are contributing notably to AKAM's growth and prospects. At its Investor Summit in March, AKAM CEO Tom Leighton talked about "megatrends" that are driving growth in our "hyperconnected world," including media distributed via the Internet, "cloud computing," cyber attacks, and mobile. Leighton highlighted a number of key data-points supporting the importance of these megatrends, including that video should account for over 90% of IP (Internet Protocol) traffic by 2015, that nearly two-thirds of enterprise application workloads will be cloud-based by 2016, that cyber attacks have increased more than 50X since 2009, and that 50 billion devices will be connected to the Internet by 2020. We believe AKAM is uniquely positioned to benefit from these megatrends, and grow notably as a result. In particular, we continue to believe that security will be a key growth driver for AKAM over the long term, and note that today Internet security firm Websense (WBSN 25 Hold) announced its proposed acquisition for a significant premium, in a private-equity transaction valued at approximately $1 billion

Our 12-month target price is $50 is based on our DCF analysis. Our assumptions include a WACC of 9.6%, average annual free cash flow growth of 12% from 2013 to 2017, and a perpetuity growth rate of 2%. We also view the balance sheet as healthy, consisting of cash and investments of $1.1 billion as of March 2013. Unlike many other larger-cap technology companies, only a relatively small percentage of AKAM's cash and investments is outside the U.S. The company also has no long-term debt. In February 2013, AKAM announced a stock buyback of $150 million, and last month the company indicated it had authorization to repurchase $119 million in shares. We see opportunities for AKAM to increasingly use its balance sheet for growth-oriented M&A and buyback activity, and wouldn't be surprised if the company looked to issue debt, given relatively low interest rates, to provide even greater financial flexibility.

Risks to our opinion and target price include the potential for weaker demand and pricing than we foresee for Media Delivery offerings (perhaps following strengthening trends in Q1 and possible unfavorable summer seasonality), notable plans for expansion and hiring across multiple areas (and we see related execution risks), and more significant competition than we anticipate, possibly related to the Performance & Security Solutions segment. People often seem concerned about competition when it comes to AKAM. We believe the company has retained its performance and market leadership in the Media Delivery area, despite numerous challenges from upstarts and carriers. Within the past year or so, AT&T (T 37, Hold) was considered a major threat, but in December 2012, the companies announced a global partnership. KT, Orange and Swisscom also are key carrier partners announced/expanded since November 2012. The investing public now seems focused on concerns related to Amazon.com (AMZN 267, Hold) and its Amazon Web Services offering, but we note AKAM has more than 125,000 servers deployed across more than 1,100 networks around the world, and we see considerable related performance and competitive advantages. We also note that AKAM's short interest was 10.26% as of May 16, just about the highest level seen since July 2010, according to Capital IQ. We believe AKAM's short interest could help enhance the stock's appreciation, if positives manifest themselves.

While we view AKAM's fundamentals favorably, we believe the recent rise in the shares, coupled with concerns including potential changes in traffic trends and plans for significant expansion and hiring, have caused us to downgrade the stock to hold, from buy, based on valuation.