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Key Conclusions
We are initiating coverage of the CDNs (content delivery networks) as of
November 27. These networks are generally considered the best way to
efficiently deliver high-quality media and computing applications. This profitable
segment of the market has enabled Akamai (for one) to show some of the
fastest growth and highest margins in the industry. At this point, we believe
that the more focused, lower-cost CDNs are positioned to gain market share,
using price and differentiated technologies as their weapons. Accordingly, we
recommend that investors focus on the new entrants in this market, primarily
LimeLight Networks, which we rate Sector Outperformer–Speculative. Some of
the other exciting new entrants are listed in the Appendix, starting on page 42.
Here we analyze the overall market based on our proprietary models, referring
readers to our reports on LimeLight and Akamai (rated Sector Performer) we
published separately today.
CDNs efficiently deliver content and applications
• CDNs calculate the optimal way to deliver content through a combination of
local caching, increased server/transport utilization, and route optimization.
• CDNs accomplish this through proprietary software and distributed servers
which are stored in leased data centers and ISP backbone capacity. This
combination increases overall ISP backbone utilization and gives CDNs
unique economies of scope while taking advantage of the economies of
scale of wholesale providers (Equinix, Level 3 and others).
• CDNs lower the average distance that packets travel and they increase the
speed by utilizing mathematical models to deliver content from multiple
distributed locations using complex routes. Data indicates that content
delivered from 1 location is usually received at less than 0.5 Mbps (standard
transmission) throughput but doubles to 1 Mbps when delivered from 30
(typical CDN transmission).
• These networks are essential for customers that experience spikes in
content or application demand (particularly for large files). Customers with
just one connection to the CDN still get the benefit of the entire CDN’s
capacity/global reach.
Internet Video Increases the Demand for High-quality
Content Delivery
Increased broadband penetration and higher broadband speeds are enabling the
adoption of rich Internet video content. We estimate 78% of U.S. online HHs
(households) will utilize broadband connections by YE10, up from 32% in 2002.
In addition, average local connection speeds are up more than 10x to
approximately 4.8 Mbps in 2006 from 384 kbps in 2003.
• The consumer demand for broadband is driven by rich media, particularly in
the last year as traditional media companies have moved content online.
Incumbent media providers require consistent high-quality content delivery
(in stark contrast to the short form, crude quality videos found today). The
large majority of high-quality traffic will need to be delivered over CDNs.
• Events such as CBS’s successful broadcast of the 2006 NCAA basketball
tournament and MLB’s live streaming of every baseball game are indicative
of the increasingly rich media experiences now commonly available over the
Internet, mostly through CDNs.
CDNs Are Increasing Their Volume Share of IP Transport
We estimate that CDN network volume will grow twice as fast as overall U.S. IP
traffic, excluding P2P, or 60% per year.
• U.S. ISP volumes should grow from 8,000 petabytes in 2006 to
36,000 in 2012, a CAGR of 28%, according to our models. CDNs’ share
of volume should grow from their current 10% to 30% in 2012.
• Consumer Internet video is the key driver, currently representing 22% of
ISP backbone traffic, but growing at 50% per year, eventually increasing to
43% of the total by 2012.
• P2P (peer to peer) does add uncertainty to our predictions, as it is a lowcost
method for transporting video. However, we do not believe that P2P is
a replacement for CDN, but a complementary solution. Recently some large
CDN providers (e.g., AKAM) outlined plans to roll out a CDN/P2P (Hybrid)
solution.
CDNs Sport the Highest Revenue Growth in the Industry
CDNs are growing revenue by 20% per year, one of the fastest network based
service revenue growth rates in our coverage universe. This is slower than the
60% growth the industry experienced in 2007, despite the increase in market
share of ISP volumes. The slowdown is the result of a much larger base,
combined with expected pricing pressure from new entrants.
• More specifically, we estimate that CDN revenues will increase from
approximately $643 million in 2006 to $2.7 billion by 2012, a CAGR of 27%.
However, we believe year-over-year growth peaked in 2006 at 63%, and is
set to decline to 13% by 2012.
• Once again, the major driver of CDN revenues is streaming media, growing
according to our estimates from $84 million in 2006 to $1.5 billion by 2012,
a CAGR of 62%. This segment should represent 44% of CDN revenues in
2012, up from 29% currently.
Barriers to Entry May Be Lower Than Previously Assumed
At one time the high costs associated with building out a massively distributed
infrastructure and developing complex routing algorithms precluded aggressive
competition in the space.
• But recent improvements in the quality of the Internet backbone have
reduced the need for overly burdensome server deployments. For example,
LimeLight Networks is able to provide an elite CDN solution with just over
4,000 servers.
• P2P techniques are becoming less associated with piracy. Due to a
significantly lower cost structure (software development exclusively), P2P
now offers the basement-level prices that could be essential to enable mass
adoption of Internet video.
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