NET - Leaving Fastly For More Axon Enterprise Stock

2023-06-30 16:47:09 ET

Summary

• In my opinion, Axon Enterprise, Inc.'s unique position, working to enhance both officer and public safety, provides a competitive moat in a growing critical sector.
• Axon's strong profitability outlook stands out when I compare it to Fastly, Inc. It is growing faster both in revenue and earnings.
• Fastly, on the other hand, continues to operate at a loss with no clear path to profitability in the next three years, which is risky in this market environment.
• Fastly, while having its strengths, presents several concerns, including dependency on a small customer base, continued operating losses, and the CEO's substantial stock sales.
• Investing, however, is not a one-size-fits-all approach. Different investors have different risk appetites and investment horizons. Fastly may still be a good fit for investors with a higher risk tolerance and a belief in the company's long-term potential.

What Is The Goal Of This Article?

The goal of this article is to walk my readers through why I closed out my position in Fastly, Inc. ( FSLY ) and will be investing these funds into Axon Enterprise, Inc. ( AXON ) stock, as it is one of my highest-conviction positions. This is just one of the many examples I will be writing about soon regarding my mission to consolidate my portfolio to 10 to 15 meaningful positions. In another article I will also explain the reasoning behind this.

Even if you do not own shares in Fastly or Axon Enterprise, I believe this article and the future ones I write could save you from making some of the more meaningful mistakes I have made in my early investing career. Please bear with me through this long introduction, but the back story has relevance to the overall article.

Some of my followers on Seeking Alpha, Twitter, or YouTube know I started my investing journey back in 2008 right after graduating from college. My uncle asked me the no brainer question of, “If I told you that you could be a millionaire by age 50, by doing just two things, would you do it?” I obviously shouted “YES, please tell me more!” My uncle had been a very hardworking individual in the manufacturing and engineering industry but was also a successful long-term investor. He said,

“All you must do is be patient and disciplined with investing annually the max Roth IRA contribution of $5,000 every year to the S&P 500 ETF ( SPY ) until you are 50 and invest the maximum match rate your employer provides for your 401K in the SPY ETF fund."

So, I made sure to save and do this for the first 11 years of my life after college. I then came across numerous investing advertisements online about individuals making thousand percent-plus returns in the past year of 2018 in individual cannabis stocks. I had to do a double take of the returns and validate they were real, which they were, but for a finite time and for all the wrong reasons of speculation. I then started listening to investing podcasts, reading stock books, and watching CNBC like crazy before making the decision to close out my position in the SPY ETF in my Roth IRA and invest half in tech stocks - which was my area of expertise in my career field - and the other half in cannabis stocks. I have tons of investing lessons from both sets of investments, that I will probably write about in the future.

I created a tech basket of stocks in 2019 and I contributed a concentrated amount of money in four specific stocks that I called my “Four Horsemen,” namely: Nvidia Corporation ( NVDA ), MercadoLibre, Inc. ( MELI ), The Trade Desk, Inc. ( TTD ), and Shopify Inc. ( SHOP ). However, I also invested the rest of my funds into many other smaller tech stocks throughout the next few years, including Fastly and Axon.

And this brings us to the present time where I have recently sold all my Fastly shares to invest more into Axon Enterprise. So, what caused me to make this change?

How Do These Companies Differ?

It's worth noting right from the outset that Axon Enterprise is operating in an entirely different arena than Fastly. Whereas Fastly is entrenched in the edge cloud platform space, Axon operates within the law enforcement technology sector, developing products and services like body cameras, digital evidence management systems, and non-lethal weapons. The implications of their divergent sectors are twofold: one, they come with distinct risks and rewards; and two, their growth trajectories and business models vary significantly. Here, we'll dive into Axon's financial performance, potential risks, and future prospects to understand why it presents a compelling alternative to Fastly for long-term growth.

But first let me explain what Fastly is in a little more detail and why I invested in the stock in the first place. Fastly, originally started as a content delivery network company ("CDN") that invested in some of the fastest hard drives and network solutions before they were popular and were cost effective, and uniquely positioned their servers across the globe to provide some of the fastest content delivery networks in the world. Fastly’s IPO was on May 16 of 2019, and it was thought to be a disruption to traditional CDN companies like Akamai ( AKAM ) or even Cloudflare ( NET ), which is another stock I still own. Fastly was gaining well known Fortune 500 logos and e-commerce companies like Shopify ( SHOP ), because of their fast delivery of Internet speeds and resiliency.

Later, it became a player in the edge cloud compute and security space and skyrocketed to becoming a near 8-bagger for me in the height of 2020! But instead of trimming my position, I held onto it all and tech stocks crumbled back down to reality. During this time, Fastly had made a few acquisitions, had their founder CEO step down to Chief Architect, and growth was slowing. Fast forward to their most recent Q1 earnings results and where the stock has fallen below its IPO price of $16, and that led me to ask myself, "Do I still want to hold onto this stock for the long term, or are there better companies in my portfolio I want to double down on?"

Fastly's Q1 2023 earnings report raised my concerns, and may also for other potential investors. These concerns, along with the long-term growth proposition of Axon, financial stability, and lack of competition Axon had, was what led me to sell my Fastly stock to grow my position in Axon. But let’s dive deeper into the specific differences in these areas, between the two companies, and you can let me know if the details support the decision.

The More Resilient Revenue Base

Axon's impressive Q1 performance and 2023 outlook reaffirms the company's commitment to robust growth. In the first quarter of 2023, the firm reported a remarkable 34% YoY revenue growth, topping $343 million, primarily driven by Axon Cloud software, Axon Fleet shipments, and demand for their TASER 7 platform. Cloud revenues soared 51% YoY, reflecting robust domestic demand for their premium integrated bundles and healthy momentum in digital evidence management, productivity, and real-time operations platforms. These growth indicators underscore Axon's strategic strength in capturing the digital transformation wave within law enforcement.

Moreover, Axon's updated full-year revenue expectation is between $1.44 billion and $1.46 billion, reflecting a projected YoY growth of approximately 22%. This outlook indicates the company's confidence in its growth trajectory and the ability to scale its operations effectively.

In terms of revenue for Fastly, it exceeded the high end of its quarterly guidance range, growing 15% year-over-year to $117.6 million. The company also improved its GAAP gross margin to 51.3% from 47.3% last year and reduced its non-GAAP operating loss, showing signs of potential financial stability and successful cost control initiatives.

Profitability And Margin Resilience

Unlike Fastly, Axon is a profitable company, which is a key indicator of its operational efficiency and financial health. Axon reported a net income of $45 million (13.2% net income margin), yielding $0.61 per diluted share. Axon also achieved an adjusted EBITDA of $65 million, driving a Q1 Adjusted EBITDA margin of 19.0%.

Axon's profitability is underpinned by robust gross margins across its business segments. The Axon Cloud gross margin stood at 73.2% and is forecasted to consistently exceed the 80% target due to their contract renewal with Microsoft Azure. While their Sensors & Other segment saw a margin decline to 38.2% YoY due to higher mix of Axon Fleet hardware sales, it's important to remember that the Fleet hardware sales spur long-term, recurring, high-margin SaaS revenue related to their ALPR (automated license plate reading) software.

However, it's worth noting that the overall gross margin did see a sequential dip to 59.5% due to increased Axon Fleet sales and professional services related to these, and an absence of the gross margin benefit of catch-up software revenue seen in Q4 2022. Nonetheless, Axon expects gross margins to remain approximately flat or improve modestly from Q1 levels throughout the remaining quarters of 2023, reinforcing the firm's confidence in its sustained profitability.

Fastly's forecast for full-year 2023 indicates continued non-GAAP operating and net losses. While losses are not uncommon for tech companies focused on growth, Fastly is not growing revenue or earnings at the same rate as Axon and Axon is profitable. Retail investors and Institutional investors of Fastly should have some concerns from the 1% sequential decrease in revenue and the negative operating income they are generating, because in the current stock market companies need to show growth in both areas to succeed. It's essential to understand if this is a macro trend or specific to Fastly. This dip may indicate challenges in capturing market share or pricing power in a highly competitive sector. While Axon has shown consistent growth, free-cash flow, and profitably, Fastly has not been able to do so.

Who Has The Stronger Balance Sheet?

Axon's financial health is further reinforced by a strong balance sheet . As of March 31, 2023, Axon had $1.07 billion in cash, equivalents, and investments. This liquidity buffer affords the firm greater flexibility to navigate economic uncertainty and invest in future growth opportunities. Moreover, with its recent induction into the S&P 500 (SP500), Axon will likely attract more institutional investment, potentially providing additional capital for the firm's continued expansion.

Fastly, on the other hand, continues to operate at a loss with no clear path to profitability in the next three years. The company also has $546 million i n cash but $705 million in debt. In times of economic turmoil, companies with solid profit margins are generally more resilient and less risky.

In addition to the profits and balance sheet discrepancies, Fastly has a CEO and other insiders who have sold a significant portion of stock, whereas insiders at Axon continue to buy more stock and the founder CEO is still leading Axon after 30 years and has taken a minuscule $33,000 a year salary because, he owns 4% of the company. Founder CEO Rick Smith is still at Axon, apparently because he believes in their mission to reduce police-public shootings by 50% by the year 2030. I believe long-term CEO Founders who hold on to their shares or buy more show confidence, and from this management team there likely is more goodness to come.

Who Has The Moat Or Less Competition?

Fastly's competitive position within the growing edge computing market, while valuable, is challenged by major players in their industry. It's essential to see how the company can improve its retention rates and attract more high-value enterprise customers in such an environment. The nature of the competition faced by Fastly and Axon could not be more different, and this disparity significantly influences their investment attractiveness. This is why I made the decision to just double down on Axon stock.

Fastly operates in a highly competitive CDN and edge computing space, jostling with well-established giants such as Amazon's AWS ( AMZN ), Microsoft's Azure ( MSFT ), Akamai (AKAM), and Cloudflare (NET). While Fastly has made admirable strides, it's continually up against these larger, well-resourced competitors who have substantial market share and established relationships with clients. This intense competition puts significant pressure on Fastly's pricing power, margins, and overall growth prospects. If a larger player in the market was truly pressured by Fastly, they could just purchase the company to limit any risk.

On the other hand, Axon operates in a space where it is a pioneer and market leader. Axon's primary focus is on the law enforcement technology market, including TASERs, body cameras, and digital evidence management systems. Unlike the crowded CDN market, Axon faces limited competition in this niche. This market leadership is a significant factor contributing to Axon's strong and stable growth, as they are largely able to set their own prices and terms without the same level of competitive pressure experienced by Fastly.

Moreover, Axon's market leadership extends beyond just product provision. They also offer an integrated software suite that utilizes AI to efficiently manage and analyze the vast amounts of data generated by their hardware products. This service has been widely adopted by law enforcement agencies, further entrenching Axon's position as the go-to provider in this sector.

This leadership position does not just mean better growth prospects for Axon, but also more predictability and stability. In the fast-paced, highly competitive CDN market, shifts in market share can be sudden and significant, as customers are often willing to switch providers for better pricing or performance. In contrast, law enforcement agencies are more likely to stick with the same provider once they have integrated their systems, especially if they are using their evidence.com cloud product. This provides a stable and recurring revenue stream for Axon.

My Conclusion

In conclusion, while both Fastly and Axon operate in the technology sector, they face vastly different competitive landscapes. Fastly's presence in the congested CDN market exposes it to significant competitive risks, which are reflected in its recent performance and near-term outlook. While Fastly certainly shows promise, the combination of slowing customer growth, continued operating losses, and fierce competition signal potential risks that I had to consider against potential returns if I held Fastly for another three plus years.

Meanwhile, Axon's pioneering status and market leadership in the law enforcement technology market have enabled robust and stable growth, making it a more attractive long-term investment proposition. I had come to the conclusion that my belief in Axon and its leadership, its consistent performance, and its lack of competition outweigh the benefits of holding onto Fastly just because of diversification sake, or because it was a previous 8-bagger, smaller market cap company that has a lower price to sales ratio. But let me know what you think, and do these facts support the decision? If you want to read more articles of mine, you can check them out here , including a deep dive on Axon Enterprise.

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