Our demand for data is insatiable. Driven by smartphones and the rise of streaming video, the amount of information being transported via the internet has boomed in recent years, and network hardware giant Cisco still sees traffic growing over 20% annually through 2022.
That made cloud-based edge computing company Fastly (FSLY +17.72%) an intriguing stock when it had its IPO in the spring of 2019. After surging in its debut and eventually doubling from its IPO price in early fall, shares are down over 35% from their highs in the fourth quarter -- putting many post-IPO investors in the red. It will most definitely be a bumpy ride, but now looks like a good time to pick up a few shares with a new year upon us.
Image source: Getty Images.
What happened in year one
First off, as Fastly disclosed in its prospectus ahead of its public debut, edge computing and CDNs (content delivery networks) are a crowded space. All of the data moving around the world can't be handled by any one player, and Fastly is an upstart going against well-established legacy CDNs like Akamai and other aspiring disruptors like Cloudflare, not to mention the biggest cloud computing providers like Amazon, Microsoft, and Alphabet investing in their own edge computing platforms.
Nevertheless, the market is massive and still growing by mammoth numbers -- especially CDNs, which Cisco says will carry 72% of all global web traffic by 2022 compared with just 56% in 2017. Plus, with mobile-based traffic growing twice as fast as the average and an increasingly diverse set of devices making requests -- from smartphones to smart watches, laptops to smart sensors -- that gives Fastly plenty of room to scoop up some market share. Its non-centralized delivery network at the "edge," which the company defines as the moment data leaves a company's control and moves to a user's device or network, is also well-suited to today's needs. Spending on cloud-based "edge" computing is expected to pick up some serious steam in the next few years, garnering tens of billions of dollars spent every year in short order.
And scoop up market share it has. In addition to picking up new customers (total customer count was 274 in the third quarter of 2019 compared with 213 a year ago), Fastly's net dollar-based expansion rate was 135% in the third quarter, implying existing users of its platform spent an average of 35% more than in the same period in 2018. Here's what that equated to in the way of business results.
|
Metric |
Q3 2019 |
Q3 2018 |
Change |
|---|---|---|---|
|
Revenue |
$49.8 million |
$36.8 million |
35.3% |
|
Gross profit margin |
55.2% |
54.6% |
0.6 pp |
|
Operating expenses |
$40.3 million |
$27.8 million |
45.0% |
|
Adjusted net profit (loss) |
($8.3 million) |
($7.1 million) |
N/A |
PP = percentage point. Data source: Fastly.
The only downside is that revenue growth does appear to be slowing, even though Fastly is still so small. The 35% revenue growth rate in its third quarter compares to 40% in the first quarter. That could account for some of the stock's recent tumble, as does the lockup period on insider shareholder ownership that expired in November. Net losses do keep adding up as well, though Fastly did have $54.7 million in cash on the books at the end of the last quarter.
What Fastly thinks happens next
Fastly hasn't yet provided numbers for its 2020 expectations, but the small internet experience delivery company sees shifts in business and consumer thinking ahead. With cloud infrastructure investment already having reduced costs substantially in the last decade, Fastly thinks that customer experience will be more important than price in the years ahead. With its software-defined network at the edge, the company thinks it is primed to pick up new business at the expense of legacy web CDN technology.
Management thinks it will be able to improve its profitability, too. As demonstrated in the third quarter, gross profit margin on services rendered is ticking up as it adds more clients to the list, and rising usage of its newer product launches (like internet security and edge computing tools) should help revenue begin to outpace growth in operating expenses. Simply put, 2019 was a year of investment after the IPO, and Fastly will focus on more profitable expansion going forward.
Nevertheless, expect a bumpy ride ahead. Shares look like a reasonable enough buy with a price-to-sales ratio currently at 9.6, but that will depend on the company being able to maintain its top-line growth trajectory and ability to start narrowing losses. The opportunity is substantial, though, and Fastly should be able to maneuver enough of the massive web traffic market to keep momentum rolling. I'm thus a nibbler on the stock right now, with plans to pick up a few shares here or there on a monthly basis while building up a larger position over time.
