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Fish or Cut Bait: Caching's cachet
By Paul R. La Monica
Redherring.com, October 23, 2000
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I have a confession to make. I hate the Internet.
Yes, even though my livelihood depends on producing content for this medium, I loathe the
Web because it is so SLOW!
I'm surprised that the marketing geniuses behind those witty Snickers commercials haven't
done one yet showing some frazzled schlep pulling his hair out as he waits for an MPEG file
to download. "Not going anywhere?"
What does this have to do with investing in technology stocks? A lot, actually. Several
companies are in the business of combating the World Wide Wait, such as Cacheflow
(Nasdaq: CFLO), Inktomi (Nasdaq: INKT), Network Appliance (Nasdaq: NTAP), Akamai
(Nasdaq: AKAM), and Digital Island (Nasdaq: ISLD).
THE NEED FOR SPEED
First, a quick primer on what these companies actually do. Akamai and Digital Island are
primarily involved in content delivery management, running networks that can reroute
Internet users to the server closest to them that stores the requested data. Cacheflow,
Inktomi, and Network Appliance, on the other hand, make servers that actually house, or
cache, data. Bottom line, all these companies are helping to improve the speed of the Web.
I'm going to focus more on the caching appliance companies, although I think Akamai, which
has been brutally sold off since its lockup expired last month, may be a good bet right now.
The company recently reported a narrower third-quarter loss than expected and a 50
percent jump in revenue from the second quarter.
On the caching side, Cacheflow has chugged along despite the tech sector's recent
cratering. While the Nasdaq has plunged 11.6 percent in the past month, Cacheflow's stock
has gained 13 percent. And with good reason. Cacheflow made a savvy acquisition recently,
purchasing privately held Entera for $440 million in stock. Entera makes software that helps
speed up the delivery of streaming audio and video files over the Web.
Brian NeSmith, CEO of Cacheflow, says there is strong demand for caching products,
particularly when it comes to streaming media, because so many companies are concerned
about what would happen to them if a Webcast caused a major network slowdown, à la the
1999 Victoria's Secret fashion show. "Streaming applications can break or come close to
breaking a network. There is the fear that this could happen at any time," Mr. NeSmith says.
Cacheflow's revenue growth has been explosive -- 389 percent over the past 12 months to
$48 million. I think the stock is worth a look, but this is definitely a high-risk investment,
especially in light of the recent run-up. Cacheflow is still losing money (although it is on
track to post its first quarterly profit in its April 2001 quarter), and the company is trading at
a positively garish multiple of 198 times fiscal 2002 earnings estimates. It would take a lot of
"fuzzy math" to make that sound cheap.
There is also intense competition. Storage giant Network Appliance is a player in caching,
but if you're going to invest in Network Appliance (which I recommend), you're making more
of a bet on storage than caching. But other tech giants are covetously eyeing the caching
market as well. In fact, Mr. NeSmith says he considers his ultimate long-term threat to be
Cisco Systems (Nasdaq: CSCO), even though the networking colossus has yet to make a
strong move in the caching area.
So although I think Cacheflow is a good long-term bet, it shouldn't be your only one in this
sector. In fact, Inktomi looks like a better value right now. Cacheflow's rise has
corresponded with a major dumping of Inktomi shares, and that doesn't make sense. For
one, Inktomi also made a recent acquisition in the streaming media area, scooping up Entera
competitor Fast Forward Networks for $1.3 billion last month. Dane Lewis, an analyst with
Robertson Stephens who follows both Cacheflow and Inktomi, says the recent streaming
media acquisitions that both companies have made put them well ahead of the competition.
Inktomi has, in part, been sold off because of concerns about its search engine software
business. On June 26, Yahoo decided to replace Inktomi's search engine software with
Google's. The stock fell 18 percent on the news that day, and it's down 48 percent since
then. But that was a foolish reason to unload the stock, as only 30 percent of Inktomi's
revenue comes from software for portals. The remaining 70 percent is derived from network
products such as caching servers. And according to estimates from Mr. Lewis, revenue in
the caching market is expected to be about $6 billion to $8 billion by 2004. So there's
enough money to go around for Inktomi and Cacheflow. Inktomi is already profitable and now
trades at 257 times estimated fiscal 2001 earnings and 112 times fiscal 2002 estimates.
There is no denying that these stocks are expensive. But I've said it before and I'll say it
again: a technology investor sometimes has to pay a premium for growth. Unless people
decide to stop logging onto the Internet altogether, there will continue to be a strong
demand for caching -- and caching-related stocks will benefit. |
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