Why Akamai Should Buy Limelight

Implications: As recent quarter’s results show, Akamai’s core business is strong, traffic is growing and their largest revenue customers are secure. Limelight, on the other hand, isn’t executing as well as anticipated, has lost a patent lawsuit and finds itself squeezed between Akamai and smaller, low-cost competitors. Patent overhang and continued losses make Limelight unattractive to companies like Level3 or AT&T. Akamai would gain significant synergies by buying Limelight in ways that other CDN competitors could not.

Analysis: Prior to going public, Limelight’s successful path to growth was as a low-cost/low-price regional media delivery service. On a smaller, US-only network and without an expensive field sales force, they targeted US-based media companies who wanted to deliver media only in the US and who wouldn’t want to pay Akamai extra for geographies or scalability they didn’t need. They successfully captured small-to-medium media business and grew nicely.  

Since raising venture funds and going public, Limelight has been spending to grow a dedicated field sales force and build out its international network far ahead of its existing customer demand with the intent of taking large global customers away from Akamai. And losing a lot of money in the process. The flaw in this strategy is that for Akamai’s largest customers, the reward/risk ratio of switching purely for price isn’t large enough to incent a change. Akamai’s service delivers everything the customers need and has proven reliability and scalability for huge traffic volume across multiple geographies. Akamai’s biggest customers aren’t willing to risk the reliability of their online businesses solely for cost savings.  

So, if Akamai is winning, why should Akamai buy Limelight?   1)      Revenue acquisition: Even at $4.50 per share, or a 30% premium to Limelight’s current price of $3.50, Limelight would be valued at 3X revenue compared to Akamai’s current valuation of 7.3X revenue based on estimates of 2008 revenue for each company.

2)      Customer and traffic acquisition: While there is overlap in customer base between Akamai and Limelight, Akamai would gain a significant new customer base and increased traffic. It also increases the base of traffic that can grow organically.

3)      Cost synergies: As Akamai did when they acquired Speedera in 2005, Akamai would migrate Limelight customers onto the Akamai network over time.  To do this, Akamai needs to ensure all Limelight features have parallels on their own network and they may need to increase capital spend to increase their native network capacity to handle the full volume of Limelight’s customer base. While this may take time, once complete, Akamai reduces costs compared to maintaining two networks as well as gains increased economy of scale in buying bandwidth.  

Why the deal could go through:
1)      One big shareholder – When Goldman Sachs invested in and ultimately took Limelight public , they effectively paid $80m for 34% of what was publicly valued at $1.8 billion driven mostly by relative valuation to Akamai. Since then, Akamai’s stock price has fallen and Limelight has delivered less than originally anticipated. At $4 per share, Goldman would exit profitably from a deal that looks like it doesn’t have the huge upside they once thought it might.

2)      This deal should pass Hart-Scott-Rodino – As when Akamai purchased Speedera in 2005, the #1 player would be buying the #2 and the deal is likely to require HSR approval. The market landscape with Limelight is similar to that of when the Speedera acquisition was approved. For all CDN vendors, the primary competitor is “do-it-yourself” and the vast majority of companies never even purchase CDN services. This limits the premium pricing any CDN can charge, particularly as the costs of basic bandwidth, servers and rackspace continue to decline. At the same time, there are a number of low-cost competitors in the marketing including CDNetworks, Panther Express and divisions of large ISPs such as AT&T and Level3.

3)      Patent Overhang – Akamai’s win in the patent infringement lawsuit creates significant overhang for Limelight. While Limelight can afford the damages and it is possible to reasonably rearchitect their product to avoid further infringement, the overhang that reduces the likelihood that another acquirer would come along. Or if one does appear, they would pay less of a premium than Akamai just because of the risk.  

Akamai has proven adept at taking advantage of opportunities in their stock and/or lawsuits to purchase and integrate Speedera, Netli and Nine Systems all to its favor. Whether Limelight is smart enough to take advantage for itself and its shareholders still remains to be seen.