Cotendo Goes to Akamai

Confirming earlier rumors, Akamai Technologies Inc. (AKAM">AKAM) recently announced that it is buying competitor Cotendo for $268.0 million in cash. The deal is expected to close in the first half of 2012. Shares jumped 18.6% to close at $31.63 following the news.

Cotendo specializes in software and services that improve the delivery of content across the Web and on mobile-device networks. In less than three years of its launch, Cotendo has been successful in acquiring a large clientele (approximately 300 customers) including some big tech companies, such as Facebook, Zynga Inc. (ZNGA">ZNGA), MyYearBook, HTC, Microsoft Corp. (MSFT">MSFT) and Google Inc. (GOOG">GOOG).

Over the last 12 months, Cotendo emerged as the most notable competitor of Akamai in the higher margin value-added services (VAS) market, after it won some major deals. Cotendo also sells its VAS at a comparatively lower price, which started putting tremendous pressure on Akamai’s higher-margin revenue growth and customer base. In the third quarter ended September 30, VAS contributed 58.0% of Akamai’s total revenue.

To counter the growing threat from Cotendo, Akamai sued the company for violating its patents in November 2010. However, this had been a regular practice with Akamai, and notably, this is the third instance when it has acquired a company earlier sued for patent violation. The other two companies were Digital Island and Speedera.

Although the current purchase price is slightly below the rumored figure of $300.0 million to $350.0 million, Akamai is paying approximately 6 times of the estimated revenue for next year, which reflects the growing value of Cotendo, in our view. Besides lowering competition from the VAS sector, the acquisition is expected to strengthen Akamai’s dominant position in the dynamic site application (DSA) market.

However, we believe that the major growth driver remains Cotendo’s mobile content acceleration products and services. We note that to-date Akamai does not have a proper product portfolio for the mobile cloud and is yet to launch a product for acceleration of mobile content delivery. The joint solution with Ericsson, called mobile cloud accelerator is expected to be available only in some markets by the middle of next year.

On the other hand, Cotendo launched its mobile acceleration product some time in 2011 and analysts believe that the ready availability of Cotendo’s product will expand Akamai’s mobile solutions portfolio going forward.

We also believe that the acquisition will provide significant competitive edge to Akamai compared to other established content delivery network providers (CDN) such as Limelight Networks Inc. (LLNW">LLNW), and Level 3 Communications Inc. (LVLT">LVLT), as well as new entrants CDNetworks, AT&T Inc. (T - Analyst Report) and Verizon Communications Inc. (VZ">VZ) over the long term.

We maintain our Neutral recommendation on Akamai over the long term (6-12 months). Currently, Akamai has a Zacks #3 Rank, which implies a Hold rating on a short-term basis.