Nov 6 2020 - Limelight Networks: An Absurd Market Cap Should Bring A Suitor
- Sector tailwinds and macro trends have given CDNs a boost this year, but some of that wind has been taken out of the sails via a market pullback.
- The fundamentals of the sector have only strengthened as covid keeps forcing shutdowns around the world and shelter-in-place orders.
- Content providers are at war to gain market share, and that war is only going to heat up and CDNs will reap the spoils.
- We may have been early to the party on LLNW, but our fundamental research is sound, and the current valuation makes a material transaction likely.
Limelight Networks (NASDAQ:LLNW) reported Q3 results that sent shares spiraling lower even on a revenue beat, though a modest one. In a world where almost every tech company is beating earnings, some by a vast margin, and then getting sold off, we can't help but think this is more "the market" than it is directed at LLNW.
However, this argument doesn't hold water when you look at the drop overall, 50% from recent highs, and that likely CAN'T be based solely on the market. We believe the market downturn only exacerbated this drop. Did fellow peers drop? Yes, they did actually. Fastly (NYSE:FSLY) has also dropped over 50% from its recent highs, and oddly enough, it is following LLNW almost identically when looking at technical charts and order flow to the downside. One can argue that the eerie similarities here might be just a sector coincidence, others feel something larger might be at play, but that is all speculation. Akamai (NASDAQ:AKAM) has dropped mildly and so has Cloudflare (NYSE:NET) from recent highs, so the sector IS in fact seeing some pressure.
Regardless of the overall factors at work here, the valuation of Limelight is SO INCREDIBLY CHEAP and ABSURD today, it's a likely target for acquisition, and though of course this is all speculative, we will explain our logic.
Valuation of a CDN
Building out a CDN network to deliver one's content is an ideal approach for a content provider looking to cut long-term costs. One can look at Netflix (NASDAQ:NFLX) and see that it built out its own CDN years ago when it saw the macro trends heading in this direction. The company used to use third-party CDNs, Limelight and Akamai included, but decided to build its own for longevity and cost cutting.
How much does it take to build a CDN? Per some digging I did and speaking to experts in the field, to acquire the ISP contracts all over the geographical locations one wants and to build out POPs or contract data center usage, the process is rather expensive. The estimate is that it takes roughly 0 million to 0 million to build a "no frills" standard CDN. That structure would get your media from point A to point B, while having minor buffering issues, some latency issues, but overall be "acceptable" for most consumer usages.
The owner would still have to pay for bandwidth, but they would get much better deals of course and more control over pricing if they took out the "middleman" of a third-party CDN. Most third-party CDNs, in fact the majority of them, use public networks and strong relationships to do the cost cutting for content providers and make it easy on them to not have to worry about all the supply chain issues. While doing that, they stand to make some decent margins as "middlemen" in this process.
How LONG does it take to build out a CDN? Experts in the field say it takes on average between three and five years to build out the "no frills" CDN. This includes negotiating contracts, acquiring some equipment and setting up POP locations, as well as partnering with data centers globally for delivery. Then, you have to add in the long process of creating software that drives the whole network and has enough features to ensure seamless delivery not to mention security protocols for safeguarding of data and content across public access lines.
Those processes take a very long time and so does applying for and acquiring the global license agreements for governments and municipalities worldwide to approve operations in their respective jurisdictions. This is how long it took NFLX to do it itself. Lucky for the company, it started back 10 years ago working on all this, so of course it stayed ahead of trends. But what about companies that are just accepting the vast changes TODAY?
Fast Forward Back to Today
Today, you have around 47 CDN networks in operation around the world. Of these 47 CDNs, only two have built out their own "private" network. Limelight Networks is one, and a private company is the other to which there is very limited information. What are the benefits of running your own private backbone operations with your CDN?
- Security - A private network is completely controlled from point A to point B as it doesn't have to travel on any public service. The less public access the data has to travel through, dramatically lower the chances of that data getting tampered with or stolen.
- Control - Using a private network allows the host company to completely control bandwidth and latency packets through their system in a way that public network users cannot. When public CDNs push data through public networks, they can't manage the flow in a scaled down way as a private CDN can. Public CDNs just have to "trust" their partner ISPs deliver it in the most efficient way possible.
- Speed - Using public CDN and public ISP connections means you have to "share" bandwidth with all other networks and traffic users. This can really slow down your content as you can't make it most efficient or maneuver it for best results, you have to trust partners to do it for you and not throttle your content or put theirs in front of yours in the priority chain.
So why don't private networks get built out if they are superior? COST and TIME. You can see above how long it takes to build out a public, "no frills" CDN, but a private one takes MUCH longer and is MUCH more costly which is why it was seldom done. It was cost prohibitive to build it out this way when time is of the essence.
Why Limelight Networks Is A Huge Target
Being one of the oldest CDNs in the space, Limelight Networks is very well known in the industry. It works with many OTT providers, has ad-supported options, live TV streaming platform, edge computing, edge functionality for optimization and customization as well as a myriad of IP and patents. Again, it is one of the ONLY CDNs with its own private network operating today.
Given today's macro trends, as mentioned earlier, big content providers like Disney (NYSE:DIS) and Amazon (NASDAQ:AMZN) are at war and pushing "all in" on streaming. Both of these giants are currently in a content war with each other buying movie rights and launching "streaming only" blockbusters. Think "Mulan" on the Disney side and Amazon acquiring the rights to "Borat 2" and "Coming to America 2". This war is only heating up, but the funny thing is, while Amazon has its own CDN via AWS, it also uses Limelight HEAVILY and make up for over 30% of Limelight Networks' revenue.
Given its massive use of Limelight Networks platform, it could easily acquire LLNW and use it to enhance the AWS CDN by a multi-use HYBRID CDN with a private network backbone. You can read about the benefits of a private CDN with mixed use public/multi CDN strategy here.
Obviously this approach could save Amazon tens of millions on its CDN costs and create several cost synergies along with strengthening its AWS and CDN offerings for the coming decades. Amazon would also greatly increase its latency and double up on a feature-rich offering of superior quality. But what about Disney?
Disney is not new to the streaming space, but it has come on VERY strong in the last six months. Just a few weeks ago, Disney announced officially it was going "ALL IN" on streaming and completely changing how it will deliver its content in the future with theaters on the outs. Disney is at a disadvantage here forced to use third-party CDNs to deliver its new trajectory business decision, but wait, why not just purchase Limelight Networks, have your very own private CDN with sub-second latency, and grab a huge advantage over any of your competitors by saving four years and a billion dollars of costs by just getting all that done in one swoop of Limelight Networks at an obscene valuation?
Well, the content providers are definitely eyeing up the CDNs to maximize profits, control over their content, and hurt the competition a little, but what about other CDNs? The CDN space is RIPE for consolidation. In the age of streaming, the biggest players are now fighting for accounts, and when they fight each other for accounts, it brings pressure on margins. Dropping prices and pressure from large clients and small clients alike is becoming commonplace in the CDN industry.
When looking at the CDNs in the space, we know that AKAM already tried to buy LLNW years ago, and when that transaction fell through, they sued them instead. Kinda spiteful, but it is what it is. That all got worked out in a settlement that is finally put behind LLNW, but would it be an ideal suitor now? I don't think so. AKAM has done amazing for itself and is chugging right along and is really the one to beat in the space. NET has a very solid offering and is also doing very well for itself. I don't think it would benefit most from an acquisition of LLNW.
That leaves FSLY. I've been eyeing the movement in FSLY as mentioned at the beginning of the article and FSLY has been tracking LLNW almost identically. Very odd. But that made me think of what a transaction might look like. You can look at FSLY's offerings and LLNW's product offerings and make a very distinct observation that they would complement each other VERY well. They seem to have only a few clients that overlap, so no cannibalism of business really. FSLY targets smaller companies and smaller videos and files more than larger streaming like LLNW. Plus, FSLY's network is public and more geared towards higher margins and efficiency than sub-second latency and quality as LLNW's.
Being a public network, FSLY had to pay big for Signal Sciences because on a public network, it needs top-notch security. LLNW doesn't have this problem, and instead focused on helping content providers stop piracy with watermarking and other digital "tricks" for illegal viewing and downloading. Why did it focus on that? Because it is running on a private network not having to worry as much about network hacking and infiltration.
Forming an all-stock transaction where FSLY issues one share for four LLNW shares would lead to something like 25% dilution, but in this type of transaction, FSLY would be buying an 80% revenue boost, a private network with a myriad of powerful tech additions, the ability to run a hybrid private/public network, gain access to LLNW's Chinese delivery licenses, and so many different ways to cut costs and give synergies to improve margins. Not to mention, the profitability of LLNW would pull up FSLY's bottom line while FSLY's raging top-line growth pulls up LLNW's already fantastic growth even higher.
COULD FSLY DO IT? Absolutely it could, and it SHOULD. FSLY has gotten a hold of a very large investment base that it could and should easily tap for rapid growth. Purchasing LLNW at current valuations is 100% an extremely wise investment at this point in time given all the money the market has given FSLY access to and its thirst for wanting to buy cheap revenue and massive growth prospects.
That type of transaction makes so much sense that we feel it would almost be foolish for FSLY NOT to do it. Then, it would give birth to a "major player" in the CDN space with roughly 520 million a year run rate, steady growth, higher margins, and an unbeatable network under FSLY's aggressive management assisted by Limelight's amazing tech focused staff and contact list. We could easily see a union of this nature trading in the 0+ share range within a matter of months given how powerful they would be in unison.
De-Risking In a Major Way
Let's continue to assume the transaction between FSLY and LLNW is a marriage made in heaven and they get off their chairs and do it, does it solve some major issues? Yes, it does. Not only does it solve the issues mentioned above about technology synergies, a hybrid CDN formation, and being able to go toe-to-toe with NET and AKAM, but it also basically solves one of the biggest problems facing BOTH LLNW and FSLY, concentration risk.
Let's take a look at why FSLY dropped when it put out a lowered guidance for Q3. It was specifically aimed at lost revenues from TikTok, its largest customer. Conversely, Amazon is Limelight's largest customer with about 30% of its revenues. In fact, 77% of LLNW's revenues come from 20 clients, and some of this is also seen on the FSLY side of the equation as well.
A merger of these two companies cuts their concentration risk IN HALF and immediately. TikTok would no longer be 18% of FSLY revenues, if these two companies combine, it would drop significantly down to only 9% of revenues. For Limelight, if the merger took hold, Amazon would drop from 30% of revenues down to 15% or just under that number. This gives the combined entity so much more stability and so many more moves for pricing power and competition without the major risks associated with client concentration. It would also bring them power in the CDN space which attracts even more big clients as they become more competitive and stable with a superior combined product offering made much more robust.
Potential risk factors must always be considered. In this case, the obvious risk factor would be LLNW continuing to go about its business on its own. It is growing revenues, but having pressure on margins in a highly competitive market. A second risk factor to consider, as mentioned above that a merger would clear up for both parties, is concentration risk. That would remain a high risk given current portion of revenues coming from large clients if there was any deterioration with those partnerships. We don't anticipate any deterioration, but it must always be considered.
Looking at Limelight Networks with a market cap of 0 million as of writing and the costs and time associated with building out a similar network, it's easy to see how saving the time and money would be ideal for multiple content providers or other players in the space.
While Limelight Networks stays at these crazy low valuation numbers, it is likely a target unless it pulls itself up on its own before a strategic transaction can occur and gets back towards to where we see it less likely to get acquired. Given a possible valuation of billion to .25 billion, a steal for both buyer and target, a buyout in this modest range would be Limelight Networks' valuation between .20 and .25 pps. It also has no debt and 5 million in cash, or roughly per share in cash as of the end of Q3.