While the market churns up and down, one stock is making a great upward move. And the rumor mill gets all the credit.
   
Trading desks are abuzz with anticipation that IBM (NYSE: IBM), Verizon (NYSE: VZ) or one of their rivals will soon make a bid for Akamai Technologies (Nasdaq: AKAM). That’s fueled a 25% gain in just 10 days. By my math, this stock has another 25% to 40% upside, even if no deal ever actually takes place. The reasons that big tech firms may be lining up to join forces are the same ones that should make this an appealing investment for you. Simply put, Akamai is in the midst of a temporary slowdown before a resumption of growth. And boy it is profitable…

I most recently took a look at Akamai in early August after its stock slid to just $22. [Read the article here] The stock slumped even further after that — into the upper teens — before a recent rebound back to $23.

 

As I discussed two months ago, this is really two businesses. The first simply focuses on web servers that sit right in the closets of major Internet access providers around the world, providing low-margin services such as video streaming. It’s a growing business in terms of volume, but price wars mean that year-over-year revenue comparisons are flat.

#-ad_banner-#The other part is where companies like IBM and Verizon are likely focusing — value-added services (VAS). To stay above the commodity-end of the content delivery market, Akamai continues to roll out a broad suite of services, focused on security, traffic measurement, application performance, ad delivery and cloud computing.

Akamai’s comprehensive suite of offerings is helping the company land new clients at a rapid clip. It brought in 147 new customers in the second quarter, well above the 50 to 100 added in most quarters. And fully half of these new customers signed up for at least one VAS, according to the company. In the past, Akamai would have had to lure customers in with its low-margin web traffic delivery service and upsell the VAS later on.

Make no mistake, companies such as Verizon and IBM appreciate that Akamai carries 20% of all global web traffic that is run on content delivery service (CDN) platforms. But what they’d really want is a piece of those higher-margin VASs. They’ve no doubt noted just how profitable these services are. “AKAM generated $111 million in cash in Q2 equating to 40% of sales,” note analysts at D.D. Davidson. Few companies can boast of 40% operating margins.

Despite the cash-sapping effect of ongoing stock buybacks, Akamai continues to build its cash levels — to a recent $1.28 billion (roughly $6.70 a share). And management appears committed to putting much of this cash back into the business to boost growth. For example, Akamai is now making a big push into international markets such as India, Brazil, Singapore, Taiwan, Japan and Hong Kong.

Major tech firms are possibly circling around Akamai for a much more prosaic reason. The company already has deep ties with many of the leading website operators. Whether you looked at fantasy football scores on sportsline.com, bought a stock on E*Trade.com (Nasdaq: ETFC), streamed songs on Apple’s (Nasdaq: AAPL) iTunes or upgraded your computer’s McAfee security software, you’re actually dealing with an Akamai server.

Right now, investors are wondering why the company’s income statement appears to be losing steam. Sales are expected to grow just 12% this year to $1.14 billion, and earnings per share (EPS) should simply be flat compared with last year, at about $1.45. Chalk it up to “macro-economic headwinds that are dampening Internet traffic growth and causing a slight stall in enterprise adoption of the company’s value-added services, analysts at Dougherty & Co say. They noted a similar slowdown in 2008/2009, but state that the 147 new customers added in the second quarter are a harbinger of future business activity. “Recent partnerships with Ericsson, Rackspace (NYSE: RAX) and Riverbed Technology (Nasdaq: RVBD) among others, also creates a foundation for re-acceleration of growth in 2012,” they conclude.

Dougherty, which carries a $36 price target on the stock, is more optimistic than others. Indeed, the consensus forecasts call for sales to grow just 11% in 2012 to $1.27 billion, while EPS is likely to grow at a similar pace to $1.62. Many analysts have concluded the recent slowdown in growth is here to stay and the company will be hard-pressed to grow faster. Then again, that’s what the pack concluded after seeing a few weak quarters in 2008 and early 2009. This bearish view proved short-sighted: the stock eventually rose from around $15 in late 2008 to more than $50 in late 2010.

Risks to Consider:  Circle your calendar for Oct. 26. That’s when Akamai is set to deliver third-quarter earnings. Recent earnings releases have proven disastrous for the stock: it has fallen at least 12% in the subsequent three days after the release on four of the last five occasions. With shares back closer to multi-year lows, and quarterly expectations fairly restrained, the chances of another post-quarter selloff are much less likely. Still, gains from the recent M&A chatter could evaporate if a deal hasn’t materialized by then and investors see that Akamai’s 2011 results remain a bit pressured.

Action to Take –> Buyout rumors often fail to materialize, so you need to assess a stock simply on its intrinsic value. On that basis, shares of Akamai appear too cheap, suffering from near-term headwinds, and they fail to reflect the long-term opportunity. If a buyer emerged, then that would simply be icing on the cake.

With shares back down at depressed levels, strategic buyers such as Verizon and IBM may be looking to pounce before the stock makes a meaningful rebound. On a fundamental basis, it’s not clear shares deserve back to that late 2010 peak of $50, but a move to the $30 to $35 range, representing 25% to 40% gains from current levels, looks to be in the cards — with or without a strategic buyer.