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Traffic Cops Of The Net


For weeks, techies were abuzz with speculation about Apple's (AAPL) plans to move into movies. And at a Sept. 12 announcement, CEO Steven P. Jobs didn't disappoint, telling a packed audience of journalists in San Francisco that Apple will begin by offering downloads of Walt Disney Co. films. But for many investors, an equally intriguing story has been the company that will make sure all those billions of video bytes don't bring Apple's iTunes Web site to a grinding halt.

Few tech companies have been hotter over the past year than Akamai Technologies Inc. (AKAM) It's a prime example of the rich profits that can be made on the Web's plumbing -- the data centers, servers, and services that keep rising levels of data traffic moving smoothly. The Cambridge (Mass.) company, which employs complex math equations and thousands of scattered servers to ship packets of data efficiently to Web surfers, saw its sales explode by 56% in the second quarter. Sales should top $400 million by the end of the year. The company is almost obscenely profitable, with operating margins of more than 30%. Its stock has tripled, to about 43, over the past year.

And if you believe CEO Paul Sagan, 47, cousin of the late scientist Carl Sagan, there are billions and billions more dollars where those came from. Akamai's customers include 29 of the top 30 media and entertainment companies, most of the top social networking Web sites, and more than half of the top 50 Internet retailers. Those companies are falling over each other to add video downloads, social networks, and interactive games, each of which hog bandwidth. The average movie takes up about 300 times the space of the typical song, so you get an idea of how crowded the Web is getting. "If we think of the ultimate opportunity as a year," Sagan says, "we're still in early January."

FENDING OFF RIVALS

The only question seems to be how much of that opportunity will fall to Sagan and his team of math wizards and server jockeys. Akamai now controls well over half the content distribution market, but competitors are swarming. Some are smaller companies that mimic Akamai, like Arizona-based Limelight Networks, which raised $130 million in a financing round led by Goldman Sachs (GS) in July. Others push a rival -- and cheaper -- technology known as peer-to-peer. But the chief worry is the prospect of big Web outfits such as Microsoft (MSFT) and Yahoo! (YHOO), both Akamai customers, deciding they need to be in the market themselves.

Akamai got its start when Tim Berners-Lee -- the man credited with creating the World Wide Web -- walked down a hallway at MIT and warned math professor Tom Leighton that congestion would become a huge problem once the Web took off. Leighton started working on algorithms with one of his graduate students, Daniel Lewin, in 1995. "I love large problems," says Leighton, "and this was ideal" because of the Web's grand scale. Three years later, Leighton and a team of 30 math and computer experts, most from MIT, had come up with the core solution, and they founded Akamai.

BOOM TO BUST

That same year, Sagan arrived as something of a misfit in this geek paradise. The son of a newspaper executive, he attended Northwestern's Medill School of Journalism and at 28 was the youngest-ever news director for WCBS-TV (CBS) in New York. But Sagan plunged into the just-emerging Internet in 1995 as president and editor of new media for Time Inc. There he founded Pathfinder, a star-crossed site that helped pioneer Web advertising, and Road Runner (TWX), the first broadband cable-modem service. Sagan started as Akamai's president and became CEO in April, 2005.

To understand Akamai's role, consider how the Internet works today. It comprises a staggering 15,000 different networks, ranging from the Internet backbone of Level 3 Communications (LVLT) to a small network run by the University of Chicago. That's double the number of networks that were operating in the late '90s, and all of them must interact for the Net to function smoothly. If all iTunes customers were sent to Apple's servers in California, the servers would soon be overwhelmed with requests. So Akamai distributes iTunes' song, video, podcasting, and audio-book catalog to its network of more than 20,000 servers, which are placed on the premises of Internet service providers and other network operators across 70 countries. (Most are happy to host Akamai's servers without charge, to help their own nets run smoothly.) Complex algorithms direct each customer to the Akamai server that can best handle their request. Usually, it's right in the same community. Without Akamai, Coldplay's song Speed of Sound would move like a tortoise.

Akamai generally charges by the number of megabits it transmits, with some volume discounts. For some Web sites, especially those powered by user communities, a few seconds of transmission speed can be crucial. Late last year the social network site Friendster was getting killed as customers had to wait seemingly forever for pages, some with hundreds of photos, to load. So it turned to Akamai. By March, Friendster's response time was slashed from 9.4 seconds to 3.4.

Like other Net infrastructure plays, Akamai got swept up in dot-com fever. Following its 1999 IPO, the stock price soared from $26 in late October to $345 on New Year's Eve. But when the Internet bubble burst, many of Akamai's customers went bust or just disappeared. Then Lewin was killed on September 11 on American Airlines Flight 11, which crashed into the North Tower of the World Trade Center in New York. In 2001, Akamai lost $2.4 billion; a year later, the share price bottomed at just 56?.

Akamai's resurgence has been fueled by household-name businesses crowding onto the Web and their growing realization that speed and reliability are essential for drawing mainstream users. Its customer list includes the Transportation Security Administration. On Aug. 10, after the agency imposed stringent new carry-on limits following a plot to blow up flights with liquid explosives, hits to its Web site surged to 15.4 million, from 500,000 the day before, without a blip.

CUSTOMER COMPETITION

But Akamai's stock multiple -- it trades at 52 times expected 2006 earnings -- makes it a rich target. Small rivals Vital-Stream (VSTH) and Limelight are enjoying blistering growth; Vital-Stream's $6 million revenues in the second quarter were just 6% of Akamai's, but they rose 57%, and its customers include MySpace (NWS) and Walt Disney (DIS). Limelight co-founder and chief strategist Michael Gordon claims that by clustering hundreds of servers in a few locations, he is actually better positioned to deliver big video files. Not surprisingly, Akamai dismisses that as marketing hype. Still, Limelight has picked up such notable customers as YouTube.com and the new movie service from Amazon.com (AMZN).

A bigger threat, though, could be looming from Akamai's own customers. Right now, Microsoft and Yahoo are both clients; Akamai says it isn't allowed to discuss Google Inc. (GOOG), which leads some analysts to believe it's one as well. Google declines to comment, other than saying it handles its own video distribution. But with those companies spending a fortune to build data centers and other infrastructure, some insiders believe they'll feel compelled to jump into content distribution to get a return on their investment.

Robert Stimson, an analyst at WR Hambrecht & Co., reasons that this market is going to become very large, hence strategic, to the major tech companies: "If you're Microsoft or Google, you want more control over this." Microsoft declines to comment, other than to point to its "mutually beneficial" relationship with Akamai. But the low-profile domain Akamai now dominates could become nearly as crowded as the Internet itself.

By William C. Symonds


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