Fastly: Revenue Could Reaccelerate, Triple To $1B By 2025

Summary

• In the near term, Fastly’s results remain uninspiring following the outage in Q2, although all customers have returned. Fastly also delivered strong customer growth in Q3.
• The big news was that Fastly announced ambitious goals for revenue to triple by 2025 to $1B, implying a 30% CAGR.
• Achieving these targets would make Fastly a growth company again and could lift the stock back to the upside, perhaps beating overall market returns.

Leon Neal/Getty Images News

Investment Thesis

Fastly (NYSE:FSLY) delivered a quite uninspiring Q3 report, with even lower guidance for Q4. However, initially, the stock actually didn't drop for once and instead was up double digits, although these gains quickly reversed.

The initial pop was most likely because, in stark contrast to the actual Q3, Fastly announced some rather ambitious goals. The company has guided to triple revenue by 2025 to $1B, which implies a reacceleration of the company’s growth rate to a 30% CAGR. Fastly will also put more focus on customer acquisition, compute (50x), and security (10x).

Since the stock has fallen by the wayside since the initial COVID-19 surge, Fastly’s renewed long-term targets may perhaps lead to investors giving the stock a second chance.

Background

I previously covered Fastly’s “devastating outage” after the Q2 report. I concluded:

Although the long-term impact from the outage may not be significant, especially if as the CEO seems to be expecting the top 10 customer returns, the market currently isn’t expecting high growth from this company anymore.

Ultimately, this means the rather sober outlook may be that although the company might well continue to grow at a decent rate (for example, the company continues to make progress with its two product introductions), the market has rerated Fastly's valuation to the downside, which may leave investors with subpar returns. Especially if the slowdown in growth isn't as temporary as it currently seems, so that would be something for investors to watch.

Q3 results and guidance

Fastly reported $87M revenue. Although a small beat, the revenue growth has decelerated from ~60% at the onset of COVID-19, to just 23% in Q3’21. Guidance for Q4 of up to $94M was also below the consensus, and implies just 12% YoY growth. For comparison, earlier this year Fastly’s guidance was implying a bit of an acceleration through the year, with FY revenue of up to $390M. The current guidance stands at $350M.

It could be noted that given the additional revenue from the Signal Sciences acquisition, the low-double-digit growth rate guided for Q4 may actually be similar to what the organic growth rate was in Q3.

Moving to the other key metrics, gross margin declined ~6 points to ~52%. Capex surged to 32% of revenue. Indeed, Fastly has continued to invest aggressively in its platform, which may indicate Fastly is seeing demand signals that the stock market so far this year clearly hasn’t seen. As a result, Fastly’s network capacity has expanded from 106Tbit/s to 167Tbit/s. Fastly noted that it has also started to invest in larger, more efficient points of presence with custom hardware, with the first one coming online in Q3. Fastly also began to roll out its “Autopilot” to redirect network traffic to less busy points of presence.

Customer count increased by a bit of 6% QoQ, which indicates that the Q2 outage isn’t impacting Fastly’s ability to gain new customers. Net retention also improved QoQ from 93% to 112%, although the TTM net retention dropped from 121% to 114%. DBNR (which is more apples-to-apples) was several points higher than overall net retention, but still trended down, likely due to the outage and the 60% growth quarter in Q2'20.

Lastly, Fastly confirmed (as had been speculated) that its largest customers had returned back to the platform, although not yet at full capacity.

2025 guidance

Fastly’s CEO actually gave quite a comprehensive overview and analysis of the business in the shareholder letter, summarizing all the challenges that Seeking Alpha contributors and others have been discussing over the last year or more.

Our trajectory over the past few years has not always been linear. We’ve experienced tailwinds, including the massive and immediate upsurge in internet traffic due to the global pandemic and the positive contributions of our acquisition of Signal Sciences. We’ve also faced significant challenges such as geopolitical factors affecting our then largest customer in 2020, the global outage we experienced in Q2 2021 and the uncertain timing of traffic coming onto our platform.

However, this was followed by Fastly’s new and quite ambitious goal of achieving $1B revenue by 2025, along with several other targets:

• Achieve $1B revenue by 2025;
• Accelerate customer acquisition (which has been one longstanding criticism about Fastly);
• Accelerate Compute@Edge adoption 50x from 1 trillion cumulative requests in Q3 to 50 trillion by 2025, partly through incentives such as a free trial program with up to $1M free credits;
• Achieve 100k enterprise developers by 2023;
• Expand the (Signal Sciences) security business 10x by 2025, including by investing in Fastly's Security Research team.

The $1B revenue target corresponds to a 30% growth CAGR, and obviously implies a stark reacceleration compared to the results discussed above: Fastly argued that given the high growth in 2020, it had tougher comps in 2021. The 10x security target would make this part about as large as Fastly overall is today, since Signal Sciences contributed 11% of revenue.

Alongside delivering compute, we want to accelerate the success of our security-lead go-to-market motion. The strong pipeline of new products that we will introduce in the coming quarters will further fuel that strategy and lead to further growth from new and existing customers. Moving forward, we are focused on execution, bringing lasting growth to our business and delivering the value to our shareholders that we outlined from the very beginning.

Valuation

Fastly is currently valued at about 6x its 2025 revenue target, or 18x 2021 revenue. If Fastly would trade at for example 12x P/S in 2025, then the stock could double (roughly back to its current all-time high). This scenario would deliver a 20% return CAGR for investors, beating the overall market.

Stock and risks

Although the stock popped after the report, which is most likely attributable to the 2025 guidance, one should not necessarily expect that this means all downside risk has disappeared.

For one, Fastly could simply fail to achieve its goals. Secondly, these 2025 goals remind me of Intel (INTC), whose stock (similarly?) saw a brief pop after the CEO transition, only to then come back to reality as the stock market went back to focusing on the near-term (quarterly) results instead of the promises Intel has made for 2025.

So for example, if Fastly would next quarter guide for 2022 growth of less than its implied 30% CAGR, then the stock could immediately head back down.

Investor Takeaway

With the new CRO, Fastly is using this opportunity to look to the future instead of the recent past, which has been plagued with some challenges such as the TikTok loss and the outage. As demonstrated above, if Fastly would hit its new growth targets, then the risk-reward could shift significantly to the upside.

In the near term, the main highlight from Q3 was the strong customer growth, even in the wake of the Q2 outage.

However, what wasn’t entirely clear yet from the Q3 report (which was below the implied 30% CAGR) was how Fastly would reaccelerate its business in the near term, since the Q4 guidance implies continued low-double-digit organic growth, which Fastly attributed to tough comps. As such, a more skeptical investor might wait for perhaps more evidence of growth reacceleration, but at least now Fastly has a firm plan which investors and analysts will hold Fastly accountable for.

Disclosure: I/we have a beneficial long position in the shares of FSLY either through stock ownership, options, or other derivatives. 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.