Sept 11 2020 - Limelight Networks: A True Goldilocks Story Of The CDN Sector

Summary

• Some competitors are growing revenues very quickly and gaining more investor attention because of it, but the cost of revenue growth shouldn't be profitability.
• There are multiple approaches to how companies choose to grow, and while one way draws much more market love, the other is much more stable and secure.
• We are digging into the numbers and interviewing management to dispel some of the myths in the CDN industry and clear the air.

As a supplement to this article, our team did an interview with Limelight's CSO and CFO. Link posted below for listening. We wanted to thank them both for their time and assistance.

The CDN industry has been under the spotlight the last few months as a strong shift in the digital world gains traction. More and more content providers are turning to streaming solutions to stay ahead of the trend, which is very smart. Linear TV, as in the normal cable and satellite type of content delivery we have come accustomed to, are on a death spiral and the direction for survival is clearly streaming and digital delivery.

We suggest opening positions in the future of digital infrastructure. Specifically in the CDN space and even more specifically in ticker LLNW or possibly AKAM. While both are excellent picks, we think LLNW is the "Goldilocks" of all the CDN competitors in the space and will attempt to show you why.

Source: Image Source

The Evolution of Content Delivery

In reality, we've seen this show before. You can easily see the iterations of this evolution from previous moves. Let's bring up VHS to DVD (hopefully we didn't lose anybody on that one that doesn't know what VHS is). For argument's sake, I will completely gloss over Beta Max to VHS.

This should take your mind back to the days of early 2000's when VHS tapes became phased out as DVD's took hold. DVD's were smaller, didn't have to be rewound constantly, held up better in regards to durability, and the video quality was far better. As DVD's got integrated into video store shelving, the VHS section kept getting smaller and smaller. Eventually in 2005, VHS was all but gone from any video store ever. That was a quick turnaround.

Then, we moved to phase 2. When DVD's moved to BluRay discs and streaming at about the same time. BluRay posed a much higher quality content viewing, but kept the same portability and durability as a DVD. Sony's Blue Ray beat out the competitor's HD DVD in the high def disc market. There was a time when you could get either format on the shelves for a short while.

But streaming took it to a whole new level. On Demand wasn't a new concept, but the level of On Demand that took hold was really a stark change. Netflix had done DVD disc delivery via the USPS for a few years. That's when they really started eating Blockbuster's lunch, but it didn't stop there. Blockbuster was actually given a chance to buy into a streaming package with Netflix before it officially launched as a partner before streaming gained steam, and they passed at the chance. We actually used Blockbuster and Netflix as a case study in business school. It truly is one of the stories of stubbornness to adapt to change that will go down as a major example in history of refusing to grasp new trends and move forward to stay relevant as times change.

HBO and Pay Per View had done big events on an On-Demand platform for years, but having a subscription service with essentially unlimited On-Demand options is a true "game changer". That game is still in its evolution today with so many services going to streaming. The premiere of "Mulan" on Disney+ which partnered with several streaming services to help facilitate delivery was a first of its kind. Charging a subscription fee and then an extra .99 on top of that to get a first peek at a blockbuster "Mulan" remake before it's released anywhere else. This completely bypassed theaters which that in itself is a huge move to digest. Pre COVID-19, something like that would likely have never been thought of, but times, they are a changin'.

So, You Understand the Evolution. Now How Do We Invest in its Future?

Well, you can either invest in the content creation companies themselves, like Disney, Sony, the major networks, or even Netflix which is creating content now. Or.... you can invest in infrastructure. Think of this in parallel with not investing in Walmart or Amazon when they went heavy into online orders, but instead investing in Fed Ex and UPS.

See, if you invest in a CDN, you are essentially investing in the content delivery networks, which is exactly what CDN stands for. It doesn't matter what your clients charge or how they choose to expand their offering to stay competitive, they simply pay you for bandwidth like a toll booth via contracts or even like midstream energy companies. For instance, Amazon has contracts with UPS. UPS doesn't care what Amazon charges for products or how they expand, UPS gets to move those packages around the world regardless. The CDN's do exactly the same thing. They move content around the world through POP servers, Point of Presence, and increase their technology offering to make delivery of content as seamless as possible.

We introduced CDN's in our first article about LLNW. It can be read here .

Time to Dig into Some CDN Numbers.

LLNW has chosen the road of profitability with modest growth versus the other road being aggressive growth while sacrificing profitability. Investors today often want to see revenue growth, revenue growth, and even more revenue growth, but don't seem to care about how that growth is achieved. This is a HUGE mistake which I am hoping to help correct now. Revenue growth is in fact great and highly sought after, but that growth has to be HEALTHY growth.

Healthy growth should be described as helping clients expand, and spending some money to expand one's network if the bandwidth loads are reaching critical mass in certain emerging markets. LLNW has done exactly this by expanding POPS heavily into Latin America and India recently. But companies like FSLY are acquiring their growth through acquisitions and fierce sales and marketing efforts. You can't really blame them I suppose, the market has given them an insanely high valuation and thus, capital funding is right at their fingertips as the market gave it to them, they have only to tap it via offerings.

But this type of money isn't actually free. Investors are willing to put their money up if the company keeps putting up huge revenue numbers. But those revenues come at a hefty price and may not be HEALTHY. Let's take a deeper dive. Recently FSLY acquired Signal Sciences for beefing up its security offering on its CDN network. Let's look at the numbers a bit, but it looks like a very expensive acquisition across all metrics and perhaps they bit off more than they could chew here.

Fastly agreed to pay 5 million for the acquisition - a significant amount relative to its scale. Let us also point out, that FSLY paid this amount, which is currently higher than the total market capitalization of LLNW which makes as much as FSLY currently does at time of writing this article. Let that sink in a second.

In addition, it offered million in restricted stock to retain Signal Sciences employees. By comparison, Fastly generated million of revenue during the second quarter, up 62% year over year, and it has yet to become profitable. Also, cash and equivalents amounted to only 4 million at the end of the last quarter.

Including the million retention pool for Signal Sciences employees, the price of the transaction corresponds to nearly 30 times Signal Sciences' million annual recurring revenue at the end of June. That represents a steep price, even in the context of the company's strong growth. Management said Signal Sciences posted a "faster annual revenue growth rate" than Fastly during the second quarter. But in this space, buying a company for 30X run rate seems absurd. Then you look at Limelight Networks trading at 2.4X revenue run rate with solid growth and you have to ask yourself what sounds like the better deal here?

However, Fastly will use its expensive stock to finance a sizable part of the transaction, which is a smart decision that will help offset the deal's high price tag. Consideration will include 0 million of cash and 5 million of Fastly, but that's a hell of a lot of money for a 30X multiple on the backs of investors. FSLY is already trading at its own crazy high valuation of 28.86X revenue run rate at time of writing.

So I have to ask again... a bargain in buying a company trading at 28.86X revenue already that just paid for another company trading at over 30X revenue run rate spending a ton of investor money... for what? Surely they are very profitable right? Wrong again.

We took the below chart from macrotrends showing trailing EPS growth.

Source: Macrotrends.net EPS Comparison

You can see from the above chart, the while revenue growth for FSLY is very rapid, their earnings per share are highly negative. They are trending up, but at these profitability levels, there is no way a near 30X revenue run rate is justified here. AKAM's current revenue run rate to market cap puts a valuation of 5.7X revenue run rate at time of writing. AKAM is a beast of a company too, and happens to be the MOST profitable of the 3. It is honestly a very good investment at current prices and given profitability and growth.

But this argument isn't necessarily for AKAM, though it's a very good deal at 5.7X we focus on LLNW. Currently, LLNW has MORE profitability than FSLY but slower growth. Though it has faster growth than AKAM, it has lower profitability. What do I call this? Baby bear. It's not too hard, or too soft, but Baby Bear's bed is JUUUUST right! Being right in the perfect place where profitability and growth intersect is right where one want's to be positioned in this environment in our honest opinion.

Let's put profitability into perspective another way. Company A makes 250 mil a year and so does Company B. Company A banks 20 Mil a year off that 250 and company B loses 20 mil a year off the 250. Does it really matter if company B grows a little faster than company A if they can't keep any of that money as profit? I seem to get this problem... too many others don't. This is so much a disparity in the market place, that Company B IS STILL valued at 15 times MORE than Company A in my scenario. But, I don't think the valuation gap between Company A and Company B lasts too much longer.

Valuation Disparity

So I bring it back to reality. How undervalued is LLNW? Well, it currently trades as of today at a measly 2.57X revenue run rate. Less than HALF of AKAM and less than 9% of the valuation given to FSLY. That valuation is ludicrous. Let's go back to Baby Bear this thing. Let's say given its profitability compared to AKAM and FSLY and its growth compared to those two as well, it truly deserves to be somewhere in the middle. If AKAM is 5.8X and FSLY is 29X, it is reasonable to say that LLNW should be trading somewhere around 17.4X revenues, right smack in the middle. But let's be even more conservative and shave off 30% of that just to be on the safe side, that gives you 12.18X revenues. This puts a fair value on LLNW at .9 billion or a .36 pps stock price.

Let's take a quick look at the enterprise values of Limelight Networks with growth numbers plugged in per management's discussion of conservative growth metrics.

Source for the above image: https://seekingalpha.com/instablog/50093457-best-on-the-street/5495669-limelight-networks-tortoise-and-hare

Conclusion

We were very very conservative and called for to in our last article in the next 12 months. We truly feel the upcoming catalysts will drive shareholder value and the stock price far higher and in short order.

Included in these catalysts are:

• Return of Sports Streaming: As sports return to screens around the world, the streaming of these will also ramp up very quickly as new streaming contracts are signed for sporting events worldwide via digital content delivery. LLNW has a very deep footprint in this part of the sector and expects revenue to ramp up very quickly with the return of sports.
• Advancement of Sports Streaming: As noted above, sporting content providers are signing more and more streaming contracts. As this change takes hold, bars, restaurants, and venues that have several TV's that show sports will move to streaming contracts as well. That is a whole segment of demand in the commercial streaming space set to expand rapidly to keep pace with the changing environment.
• Large Customer Wins: LLNW has had multiple large new customers in beta testing for months and management has stated those very significant contracts will be announced very soon as these clients launch for Q4 and heavy demand right as competition heats up.
• EdgeFunctions: With the recent official launch of EdgeFunctions, new and existing clients will be able to streamline their media and make it more accessible, enhance the delivery of the media, and control more aspects of how and where the content is delivered.
• Seasonality: Q4 is historically the best quarter for seasonal reasons and this year will be no exception. In fact, with more people bunkering in their home with friends and family for the holidays via small gatherings, gaming and video / movie streaming are going to take center stage.
• Launch of PS5: LLNW has had a contract with Sony for over a decade to do a large part of their gaming downloads. With the release of PS5 this fall, and games moving to digital download formats, the downloads of games, gaming updates, and software upgrades will be practically endless. Limelight Networks is set to get a huge bulk influx of business through all those coming downloads. The content is VERY large for new games with better graphics and more options than ever, the bulk of which all have to be downloaded from massive Sony servers via Limelight Networks.

We feel that hands down, LLNW provides the absolute best value in the CDN sector today and rate it a STRONG BUY, SCREAMING BUY, or TABLE POUNDER. Pick your poison. We also rate AKAM a MODERATE BUY. While we aren't bullish at all on NET or FSLY, we give them a NEUTRAL rating as we have no idea how long the market will be irrational and inflate their stock prices, but given what we've seen lately in stocks like TSLA, for all we know they could move even higher too.