FSLY - Fastly: Powerful Tailwinds

2023-05-26 16:17:49 ET

Summary

• Shares of Fastly have resumed a YTD rally that has seen the stock nearly double since the beginning of January.
• This rally is supported by strong results, as Fastly continues to grow revenue double digits in the wake of a depressed macro environment.
• Particularly, Fastly is seeing enterprise customer expansion as well as a successful rollout of its reseller partner program.
• Economies of scale are also helping Fastly boost gross margins and overall profitability.
• Still trading at just ~4x forward revenue, Fastly has ample room to continue rallying.

I've emphasized this a lot so far in 2023: The best move to make during this volatile market season is to invest in "growth at a reasonable price" stocks. Over the past week alone, we've seen a huge bounce back in the small/mid-cap tech space, especially as investors look ahead to the Fed slowing down or potentially reversing the pace of rate cuts in response to a wobbly economy.

Fastly ( FSLY ) is a great name to look into in this space. The cloud-native content delivery network has already had a stellar year so far, with its stock up nearly 2x. Enthusiasm for Fastly continued to bloom after the company's fiscal Q1 earnings release dropped in early May.

I remain bullish on Fastly and continue to hold onto the stock in my portfolio, despite the year-to-date strength that I view mostly as correcting last year's unwarranted slide. At a very high level, a bet on Fastly is a bet on the internet - as long as you believe that we will continue to increase our internet usage across the globe and that companies serving up internet content will want the fastest and most seamless backend technology to deliver the best web experience, then you believe in Fastly.

Even this year, amid macro pressures, Fastly has continued its trend of strong net expansion within its current customer base, while also adding new enterprise customers to the fold. Economies of scale, meanwhile, are giving Fastly a better year-over-year margin profile that will eventually help it tilt toward profitability.

Here are my key reasons to be bullish on Fastly:

• Fastly's usage-based business model opens the door to tremendous growth - Fastly, alongside other software/technology peers like Twilio ( TWLO ), was among the companies that could fully take advantage of the pandemic and the increase in internet traffic that came with it. Because Fastly's pricing is based on volumes of content delivered, as the underlying customers continue to grow their websites and traffic, Fastly's revenue will also grow proportionally. Fastly's dollar-based revenue retention rates recently clocked in the ~120% range, which is an enviable target vis-a-vis other tech growth stars.
• Greater customer diversification - 2020 caused a big disruption for Fastly when it lost its biggest customer, TikTok. Since then, however, Fastly has proven its "horizontal" nature by landing customers of various industries, and the fact that it is still growing revenue in the mid-20s proves that it has reduced its reliance on single large customers. The company now has a base of approximately 3,000 total customers, with about ~500 enterprise customers between them.
• Best of breed - Though CDN is not a new technology category, with companies like Cloudflare ( NET ) and Akamai ( AKAM ) preceding Fastly by several years (and in Akamai's case, decades), Fastly is one of the most highly regarded CDN vendors. Fastly's addition of Signal Sciences and its web application firewall (WAF) tools also flesh out Fastly's offering. The company was also recently recognized as a Challenger by the influential Gartner Magic Quadrant reviewers.
• Economies of scale - As Fastly grows, it achieves economies of scale on its CDN network. It has already started to pare down hardware spend in an effort to improve gross margins. Capex spend as a percentage of revenue is also expected to continue trending downward. As Fastly's existing customer base continues to boost usage, margins will continue to expand.

And best of all from a stock perspective, Fastly shares are quite modestly valued. At current share prices near $15, Fastly trades at a market cap of just $1.96 billion. After we net off $664.1 million of cash and $705.4 million of debt on Fastly's most recent balance sheet, the company's resulting enterprise value is $2.0 billion.

For the current fiscal year, Fastly has affirmed its revenue guidance range of $495-$505 million, representing 14-17% y/y growth for the full year:

This puts Fastly's valuation at just 4.0x EV/FY23 revenue - which, in my view, gives Fastly plenty of room to continue rallying (not that I believe that Fastly will ever retain these levels, but it's useful to recall that during the pandemic the company traded at a low-teens multiple of revenue).

The bottom line here: With secular growth drivers, margin tailwinds, and high expansion rates, there's a lot to like about Fastly, especially at a ~4x revenue multiple. Stay long here.

Q1 Download

Let's now go through Fastly's latest quarterly results in greater detail. The Q1 earnings summary is shown below:

Fastly's revenue grew 15% y/y to $117.6 million, beating Wall Street's expectations of $116.2 million (+13% y/y) by a two-point margin. Revenue growth did, however, decelerate from 22% y/y in the fourth quarter.

Management cited healthy traffic and expansion trends in the quarter. As seen in the chart below, the company added 38 net-new customers to end the quarter at 3,100, while it also added seven net-new enterprise customers (defined as a customer that generates more than $100k in annual revenue). Dollar-based net retention rates, meanwhile, stayed elevated at 121:

Here's some further anecdotal color from CFO Ron Kisling's prepared remarks on the Q1 earnings call :

We continue to see healthy traffic expansion from our enterprise customers. And as we've shared in the past, given our relatively smaller market share, we continue to benefit from share gains in what is typically a seasonally weak quarter relative to the fourth quarter. This coupled with the launch of our partner program, simplified packaging offerings, and investments that our go to market efforts give us confidence in our 2023 revenue guidance."

From a profitability perspective, the company notched a 300bps y/y gain in gross margins, up to 55.6%. This was a slight sequential decrease from 57.0% in Q4, but that's driven by the fact that Fastly's network is set up for peak traffic (which happens in Q4). As traffic volumes overall grow and expansion rates remain high, the company will be able to continue optimizing its infrastructure to deliver growing margin gains.

And from an adjusted EBITDA standpoint, Fastly dramatically shrunk its losses to just -$1.9 million, representing a -1.6% margin: versus a loss of -$7.8 million, or a -7.6% margin in the year-ago quarter.

Key Takeaways

Though no longer exactly the market darling it was during the pandemic, when every investor piled on all stocks cloud and Internet-related, there is tremendous value to be had here as Fastly continues to quietly exceed its growth targets and using enterprise expansion to generate economies of scale. Keep riding out the upward momentum here.

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