I hope this will help.
Craig
Inktomi: A Complete Analysis
May 14, 1999
by Street Winetroub
An analyst with a major Wall Street investment bank
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The basic criteria for recommending stocks to readers of StreetAdvisor.com is simple - solid revenue growth, demonstrable operating margin improvement, a competitively sound business model, upside potential and a reasonable valuation.
Inktomi satisfies these criteria handily.
On a happy side note, my previous recommendation - RealNetworks (see RealNetworks Complete Analysis) - is up 57.5% in the six weeks since I recommended it. This compares very favorably to the 12.4% return for the Bloomberg Internet Index - a comprehensive Internet Index with 101 members - over the same time period.
Company Profile
Inktomi develops and markets search engine, network caching and shopping engine solutions to the world's largest Internet companies. Inktomi partners with and provides infrastructure solutions to @Home Network, America Online, chello broadband, CNET, CNN, GeoCities, Intel, RealNetworks, Sun Microsystems, and Yahoo!. The company has offices in North America, Europe, and Asia.
A Pure Play On The Growth Of the Internet
The biggest bottleneck on the Internet right now is bandwidth. Inktomi's traffic server network caching helps alleviate bandwidth issues by allowing caching or storage of frequently requested documents closer to where the user is, thereby reducing the amount of traffic flow over large distances and increasing response times. In addition, Inktomi provides search engine technology and serves as the back-end search and query engine for portal search engines.
I liken Inktomi's market positioning to the mining supplies providers back in the days of the great Gold rush. While most of the miners made very little money, the mining supplies providers made a fortune. Inktomi is agnostic to who emerges as the winner on the Internet, as long as the winner uses Inktomi products. So far, some major players including America Online, Yahoo!, AtHome are Inktomi clients. In fact, the list of Inktomi clients is deep and impressive. (I refer interested readers to the company website for a complete listing).
Sound Recurring Revenue Business Model
Inktomi's revenues are recurring, and are based on the number of search queries, page requests or shopping queries. As such, Inktomi's revenues will scale directly with the exponential growth of it's clients, as well as the secular growth of the Internet. This provides tremendous visibility to the revenue stream, which in turn is highly appreciated by risk averse investors.
Proprietary Products = Barriers to Entry
Inktomi's search engine and network caching technology emerged as a result of a three year government funded research project in the early-mid 1990s. The company had invested almost six years of private (three years) and commercial research (three years) before it came public in February 1998. The company's roster includes a disproportionately high number of researchers and some of the most experienced and knowledgeable authorities on the Internet infrastructure business.
Competition
Network Cache Market - CacheFlow, Inc., InfoLibria, Mirror Image Internet, Inc., Network Appliance, Inc., and Novell, Inc..
Inktomi's network cache products are currently the cream of the crop. Network Appliance recently dropped out of a face-off of its products versus Traffic Server. The best validation of the quality of Inktomi's solution is that it is used by America Online, currently the highest traffic generating service in the world.
Recent customer wins - Cable & Wireless USA, Concentric Networks, Exodus Communications, Telefonica in Spain, and Telepac in Portugal - are a further testament to the quality of the caching solution.
Search Market - Compaq Computer Corporation (Alta Vista), Excite, Inc., Infoseek Corporation, Lycos Corporation, and Northern Light, Inc.
The opportunity for Inktomi in this market is huge as well. The market is big enough for all competitors to grow and flourish.
Shopping Engine Market - Jango.com, owned by Excite, Junglee, recently acquired by Amazon.com, Inc., mySimon.com, Inc., and Bottom Dollar.
Amazon.com poses a justifiable threat since it beat Inktomi to market. However, based on our review of the product, we feel that the Inktomi shopping engine offers a better graphical interface and more compelling content such as Consumer Report product reviews. The good news is that any revenues received from the shopping engine are incremental revenues or "gravy".
Well-positioned for Broadband
Inktomi recently announced the development and deployment of streaming media network caching solutions, the first and only streaming media cache solution available. Inktomi has partnership agreements in place with At Home and RealNetworks, both major players in the move towards broadband connectivity.
AtHome Network, chello broadband n.v., SoftNet's ISP Channel and Sandpiper Networks have purchased the new Media Cache and are preparing for deployment across their networks worldwide. The caching solution is based around RealNetworks RealSystem G2. The Media Cache Option is an add-on component to Inktomi's Traffic Server that tightly integrates RealNetworks' RealSystem G2 media delivery technology with the Traffic Server network cache platform.
Again, Inktomi is perfectly positioned to benefit from the deployment of broadband.
International Operations
Each quarter, we continue to be pleasantly surprised by the number of international customers signing up for Inktomi's products. Most recently, Europe's chello Broadband, Groupo Expresso, Yahoo!Japan and Latin America's StarMedia Network have signed up for Inktomi's search engine products. Further extending its European reach, INKT recently signed an agreement with British Telecom to use and resell the Inktomi search engine services across Europe.
Inktomi's recently announced eight new customers for its search engine services are : BellSouth, chello broadband n.v., ComBus, Global DataTel, GoProfit, StarMedia Network, ThundaTech, and 4anything.com. This brings Inktomi's worldwide search engine customer base to over 25 portals and destination sites on five continents.
Shopping Engine - New Product, New Revenue Stream
As of last month, Inktomi had already signed up more than 20 portal and destination sites for its shopping engine technology. CEO David Peterschmidt recently said Inktomi is planning to bring on more portals for its new shopping search engine technology this year. The company believes that it could add another 10 portals by the end of the calendar year.
Over 350 merchants offering more than 2 million products have also signed up, including 800.com, Art.com, ARTiSANgifts.com, BabyCenter, barnesandnoble.com, bedandbath.com, Beyond.com, Bluefly (BFLY), The Bombay Company, BrainPlay.com, The Company Store, CyberShop (CYSP), Domestications, Egghead.com, Fogdog Sports, Fossil, Gear.com, GreatFood.com, Gump's, Improvements Catalog, International Male, Kitchen and Home, MotherNature.com, Muzic Depot, NECX, Outpost.com, PC Flowers & Gifts, ProFlowers, Reel.com, REI.com, Silhouettes, Skechers, and Sports Superstore Online.
The company is planning to officially launch its shopping engine technology in the coming weeks. Initial reviews of the product have been very impressive. We believe that the decision provide Consumer Reports product reviews on the shopping engine provides instant credibility and a competitive advantage for the service.
Growing Revenues At 300% a year With Demonstrable Improvement In Margins
There are very few companies out there - in any sector or universe - that are growing revenues in the 300% plus range year-over-year. Inktomi is one of them. In the most recently reported quarter, revenues were up 323% year-over-year, and 36% sequentially. Just as important, operating expenses as a percentage of sales have been rapidly improving from 239% of sales in Q1 98 to 137% in Q1 99 - a 102% improvement in margins in just 4 quarters!
Scalability
A testament to Inktomi's superior technology is the fact that during the previous quarter, INKT moved from handling 1 billion daily requests to handling more than 2.5 billion daily requests from AOL's web users, without noticeable degradation in service.
Cross-Selling Opportunities
We believe that significant opportunities currently exist for INKT to cross-sell search engine, caching and shopping services to its impressive list of current customers. The shopping engine technology is particularly well-suited for this purpose, as it is a natural extension of the search engine services INKT currently provides.
Fourth Product Line To Be Announced in Third Quarter
CEO Peterschmidt recently hinted at a new software application to be unveiled towards the end of the company's third quarter. He expects the new product to begin generating revenue by the fourth quarter. Peterschmidt described the technology as "complimentary to its search and shopping engines" and that it would be folded into its portal services side of its business. This should serve as a potent catalyst for further stock appreciation.
Strong Research & Management Team
INKT's proprietary products, premier client roster, and industry positioning all point to the strong research knowledge base and management expertise. Inktomi's products were developed as part of a government funded research product in the early-mid 1990s. Prior to coming public, INKT researchers spent an additional 3 years of commercial research in further developing the products. Both the search engine and traffic server products were developed during the six years of research by INKT research scientists.
Valuation - Fairly Valued, But Tremendous Upside and A Must Own Stock
Breakeven by Q1 2000. Our conservative model projects Inktomi will be profitable in Q1 2000, experiencing explosive earnings growth thereafter. The company's price/sales ratio is about 55 on forward 12 month sales. This is steep, but not unreasonable for a company growing at 300% a year with a solid business model and barriers to entry.
The company has the potential to generate high teens in net margins a couple of years out. The company is fairly valued in our opinion, but is a must own stock due to the tremendous upside potential, proprietary products, incremental new product revenues, customer relationships, broadband positioning, and research knowledge base.
We recommend INKT as a core holding in any aggressive investor's Internet portfolio.
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