The content delivery network (CDN) specialist Limelight Networks (NASDAQ:LLNW) posted disastrous first-quarter results. Despite the secular growth in its video streaming market, revenue declined because of pricing pressure and poor operational execution.
Looking forward, new CEO Bob Lyons announced an ambitious goal that should provide significant upside for shareholders. But what are the chances for the company to succeed given its disappointing recent performance?
Disastrous first-quarter results
Limelight Networks developed a computing infrastructure for video streaming content to be delivered with optimal performance. So the company’s underwhelming first-quarter results are puzzling given the current tailwinds in its core market.
The pandemic lockdown measures enacted last year boosted the consumption of online services. And the cord-cutting trend is materializing with the recent launch of several streaming services. As an illustration, the entertainment giant Walt Disney announced in March it had exceeded 100 million Disney+ subscribers.
Yet despite that favorable context, Limelight Networks had posted disappointing fourth-quarter results last year because of pricing pressure from a few large customers. And with continued pricing pressure, revenue dropped 10% year over year to $51.2 million during the first quarter.
More worryingly, traffic reduction from some large customers because of the poor performance of the company’s network also contributed to that top-line decline. Indeed, network performance is key for the company to acquire and retain customers. And Limelight Networks can’t afford such setbacks against strong and growing competitors, such as Cloudflare, Fastly, and Akamai Technologies. In addition, customers can easily switch their video streaming content from one CDN to another — and some did during the first quarter.
What’s more, the drop in revenue involved a lower gross margin because of the fixed costs of the company’s computing infrastructure. The gross margin dropped to 24.4%, down from 36.4% in the prior-year quarter. Add to that higher operating costs, and net losses reached $23.8 million (including $11.7 million of restructuring charges), compared to a loss of $5 million the year before.
Diversifying the customer base with more services
Of course, Lyons has a plan to overcome the company’s huge challenges. In the short term, Limelight Networks will be trying to regain customer traffic by optimizing its network performance. During the earnings call, Lyons discussed encouraging results in that direction over the last few days. Yet he expects second-quarter results to remain stable quarter over quarter, which suggests improvements remain modest.
And to improve its gross margin, the company will develop services to diversify its concentrated customers (its top 20 clients represented approximately 79% of first-quarter revenue). Those concentrated video streaming customers consume peak network capacity at the same time, which leaves underutilized network capacity during quieter periods of the day. Management will give more details about its plans, which will most likely include extra cybersecurity services, during a strategy session this summer.
Diversifying customers with extra services seems like an attractive idea, but the challenge is enormous, as Limelight Networks will increasingly compete against Cloudflare, Fastly, and Akamai. Those competitors have already developed such features over the last several years. And with their larger and growing scale, they will still be outspending Limelight Networks on research and development efforts.
An ambitious goal
Looking forward, with increasing network traffic volume exceeding price compression, management expects stronger performance during the second half of this year. It forecast revenue to land in the range of $220 million to $230 million, down 2.3% year over year at the midpoint.
More surprisingly, Lyons revealed management’s ambition of turning Limelight into a “rule-of-40 company” within three years. Basically, that means he expects the addition of revenue growth and profit margin will exceed 40% by 2024. Given the anticipated declining top line and negative bottom line this year, it’s hard to believe Limelight Networks can hit such an ambitious target even when taking into account the secular growth in online services over the next several years.
If the company reaches that goal, the upside potential for investors is huge, though. The stock is trading at a price-to-sales (P/S) ratio of only 1.8, based on the midpoint of the anticipated full-year revenue range. In contrast, the market usually values rule-of-40 companies with double-digit P/S ratios. If you assume a P/S ratio of just 10 for Limelight Networks, its market cap would correspond to $2.25 billion — approximately 5.7 times its current market cap.
However, given its pricing pressures, operational challenges, lack of scale, and strong competition, I’m struggling to see how Limelight Networks could become a rule-of-40 company in a few years.
Thus, investors should view the CEO’s long-term plans with skepticism and consider staying on the sidelines as long as the company’s operational performance remains weak.
This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.
View more information: https://www.fool.com/investing/2021/05/04/1-number-from-limelight-networks-q1-earnings/