Why I'm Still Not Buying Fastly
Summary
- Fastly stock tanked Wednesday evening following disappointing quarterly results.
- Downbeat forward guidance and the CFO stepping aside only added to the gloom.
- The sharp decline might make you think there's a good buy-the-dip opportunity. However, Fastly stock actually looks expensive, even now.
- Looking for a helping hand in the market? Members of Ian's Insider Corner get exclusive ideas and guidance to navigate any climate. Learn More »
Fastly (NYSE:FSLY) had quite a sprint in 2020, and its shares have collapsed with equal speed this year. The company, for those unfamiliar, is a content delivery network "CDN". Fastly serves as an intermediary for internet traffic, helping to optimize internet speed by using caching and other techniques. Services such as Fastly and Cloudflare (NET) aim to make the internet safer, faster, and more reliable.
In addition to its core CDN services, Fastly is able to add other services for content providers, such as enhanced security. This sort of offering became pivotal last year during the height of Covid-19. As people had to work and learn from home, shop online, and obtain far more entertainment over the internet, it created strain on existing internet infrastructure. A trustworthy CDN like Fastly became integral in handling the sudden burst in internet demand.
FSLY stock had launched its initial public offering in 2019 to little fanfare. The stock opened around $25 and stayed in the $20s until Covid-19. With Covid, however, the stock more than quintupled in short order:
Now, however, Fastly is sprinting in reverse. The stock had already slipped to $60 in recent days and then has plunged lower, falling below $50 as of this writing following a downbeat earnings report.
As the stock was over $100 just a few months ago, $50 might look like a steal. However, FSLY stock is far less obvious a buy here than it might seem at first glance.
A Truly Dismal Q1
Fastly came up short on its earnings expectations Wednesday. This was particularly bad since Fastly had come up light on its previous earnings as well, and so analysts had assumed guidance this quarter might be conservative after that. But no, the business has simply decelerated tremendously.
It starts on the top-line, where year-over-year revenues grew 35%. In theory, that might sound good. But stop and think about it for a minute. Q1 of 2020 was just a couple weeks into the pandemic. Fastly's business hadn't really begun to take off yet.
So, Q1 of 2021 should have absolutely blown last year's quarter out of the water. Instead, during the single biggest ever catalyst for increased internet usage, Fastly only grew revenues 35% year-over-year. If not now, then when? Again, in isolation, 35% revenue growth is great. But when you come into an earnings report at more than 20x sales and are riding a massive tailwind for your product's demand, these revenue numbers simply aren't good enough.
It's not stopping here, either. Fastly guided Q2 revenues to just $84-$87 million, whereas analysts had been looking for almost $92 million. Fastly also projects an operating loss roughly twice as large as the market had been anticipating.
On the conference call, CEO Joshua Bixby did point out that if you excluded former key customer TikTok's departure, growth would have looked a lot better. That's true, undoubtedly. Bixby notes that Fastly is growing at 20% on its 2020 base if you use normalized numbers. However, is 20% on an adjusted basis that great? And again, in a pandemic, you'd think Fastly could have won some important new customers to replace TikTok.
So, the numbers were pretty bad. But was there any other news? Well, yes, but unfortunately, not of the positive variety. Specifically, CFO Adriel Lares is leaving. The decision was seemingly unexpected as the company doesn't have a replacement lined up yet.
In short, the company released another quarter of disappointing numbers, guided down next quarter even more, and had the CFO resign. The overall message here is pretty clear.
The Zoom Video Comparison
The other thing that should give Fastly investors pause is that it has often been compared to Zoom Video (ZM). On the way up, they were mentioned in the same breath as the biggest winners from the pandemic. They traded similarly during the great rally and are now unwinding at almost the same speed:
It's easy to get hung up on specifics of Fastly's fall, such as all the political drama around TikTok and now the CFO resigning. However, at the end of the day, it seems investors drastically overestimated how much of the pandemic-induced demand for internet video and services would actually stick.
It's not hard to blame investors for getting a little carried away last fall. There were still no vaccines on the market, and it was a dreary time stuck at home heading into winter. Given behavioral biases, it makes sense why investors rushed into these sorts of names. However, that period has long since passed.
How Far Could Fastly Fall?
If we say Fastly is worth 10x sales, then that'd be $3.85 billion based on management's current full-year guidance. Even that might be a tad optimistic, given the current earnings results versus expectations. But assuming Fastly can deliver, we'd have a $3.85bn market cap. On 115 million shares of stock outstanding, that'd work out to a share price of around $33/share.
Is that too pessimistic? It might seem so given the bearish price target. But which assumption is wrong?
Why would people pay more than 10x sales for a rapidly slowing unprofitable business that sells an arguably commodity-nature product such as CDN services? A higher revenue multiple may have made sense last year when it was unclear how long the pandemic would last, but now we're at the turning point of the virus and Fastly's growth opportunities have apparently dried up. I'd also note that Fastly earns a gross margin of just 56%, which is quite low by software/tech standards. Given that Fastly produces much lower-value added revenue than many peers, that argues for a lower P/S ratio as well.
Meanwhile, given quarterly results out of Fastly recently, it's hard to think that management is sandbagging guidance at this point. The company generated $85 million this quarter and is guiding to $84-$87 million next quarter (sequentially flat). So even hitting $385 million for the full year might be generous, as they're currently only at a $340 million run rate. And assuming a 10x multiple of $385 million of sales gets you another 30% downside on the stock from here.
Resist the urge to think FSLY stock must be a steal simply because it's dropped a long way in a hurry. On the flip side of that coin, the stock was at $20 before the pandemic, so even if it ultimately settles at $30 or $40 per share, it will still have posted large gains since Covid-19 hit.
Going forward, investors will need to separate the tech companies that truly have special services and intellectual property from the ones that simply rode the wave with the surge in tech stocks last year. Unfortunately for Fastly, it falls in the latter category.
There are still bullish scenarios for the stock. In particular, if it drops enough, Fastly may become a buyout target. But it isn't necessarily cheap here yet by any means. In fact, it's easy to see fair value in the low $30s at this point.
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This article was written by
Ian Bezek is a former hedge fund analyst at Kerrisdale Capital. He has spent the decade living in Latin America, doing the boots-on-the ground research for investors interested in markets such as Mexico, Colombia, and Chile. He also specializes in high-quality compounders and growth stocks at reasonable prices in the US and other developed markets.
Ian leads the investing group Learn more .Analyst’s Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Seeking Alpha's Disclosure: Past performance is no guarantee of future results. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. Any views or opinions expressed above may not reflect those of Seeking Alpha as a whole. Seeking Alpha is not a licensed securities dealer, broker or US investment adviser or investment bank. Our analysts are third party authors that include both professional investors and individual investors who may not be licensed or certified by any institute or regulatory body.
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Comments (52)
4/26/21 - sell 14,423, proceeds = $1,106,388.81
4/19/21 - sell 14,423, proceeds = $975,571.72
4/12/21 - sell 14,423, proceeds = $981,773.61
4/5/21 - sell 14,423, proceeds = $994,321.62
3/29/21 - sell 14,423, proceeds = $925,379.68
3/22/21 - sell, 14,423, proceeds = $1,036,725.24
3/8/21 - sell, 14,423, proceeds = $927,398.90
2/17/21 - sell 23,098, proceeds = $2,180,451.20
11/17/20 - sell 19,724, proceeds = $1,549,911.92
11/9/20 - sell 57,688, proceeds = $4,092,963.60
11/2/20 - sell 92,308, proceeds = $6,860,330.56
10/26/20 - sell 92,308, proceeds = $7,720,641.12
10/12/20 - sell 92,308, proceeds = $11,679,731.24
10/5/20 - sell 92,308, proceeds = $8,874,491.12And so on, including a sale of $43.4m of stock on 8/7/20 followed by a $7.3m sale three days later.He sold approx. $140m worth of stock in 2020. Now he's selling about $1m per week!I get that he's on a plan and that he deserves some liquidity but the $140m wasn't enough to tide him over?Meanwhile, they're all selling like mad - the CEO, the CFO, the Chief Counsel.The current CEO, Joshua Bixby, is a VC-type not a tech company CEO. And he's selling 500,000 or so per month lately.Could the flag be any redder?
I am not happy that TikTok was able to walk away so easily, and that IMO presents the weakest spot in Fastly's investment case - their tech is great but not a must-have (new sales are not going to come easily). TikTok was a special case though. Branding them as "defection" is a bit disingenuous.
