Cloud services provider Fastly's (NYSE:FSLY) stock price has increased by more than 650% from its March lows. Granted, the coronavirus pandemic boosted the edge cloud platform's first-quarter results, and the company will be releasing a promising product soon. But given the spectacular market reaction over the last few months, has the stock become too risky?
More than a traditional content delivery network vendor
Fastly's core business looks simple. The company established a network of 72 data centers around the world to improve the performance of web services by hosting them physically closer to users. For instance, the shopping platform Shopify is one of Fastly's 1,837 customers, which means you might use Fastly's infrastructure, without knowing it, when you shop online.
But the reality is more complex as Fastly has built its own innovative solutions to provide more flexibility and control to its customers compared to traditional content delivery network (CDN) vendors. For instance, the company's customers can update their websites almost instantaneously, and they can rapidly identify and solve issues thanks to Fastly's granular near real-time logging capabilities.
Yet despite its strong compound annual growth rate (CAGR) of 34% since 2017, Fastly's scale remains modest. The company's first-quarter revenue of $63 million paled in comparison to the legacy CDN player Akamai Technologies' revenue of $764 million during that time frame.
Strong revenue growth and losses
Given the increasing demand for internet services during the lockdown periods implemented to try to limit the spread of COVID-19 in the past several months, Fastly posted better-than-expected first-quarter results. Also, management raised its guidance, forecasting full-year revenue to land in the range of $280 million to $290 million, which represents a solid year-over-year increase of 42% at the midpoint.
However, because of its smaller scale and its investments in its tailor-made technologies and data centers, Fastly has been generating weaker gross margins than its competitors. And when you add sales & marketing and research & development expenses that are necessary to remain competitive, the company is still far from reaching profitability with its negative operating margin of 19% in Q1.
During the last earnings call, management expressed confidence in reaching profitability with scale and operating leverage -- without giving a specific time frame, though.
The next step: Compute@Edge
Management estimates its CDN, streaming, and edge activities will tap into a market opportunity of $35.4 billion by 2022, which gives the company plenty of room to gain scale.
In comparison, following the spectacular market reaction over the last few months, Fastly's market capitalization reached $8.7 billion. The tech stock is now staying close to its all-time highs with a lofty enterprise value-to-sales ratio of 40, which indicates investors expect the company to capture an increasing part of its addressable markets over the long term while improving its margins.
But that implies Fastly will succeed with its next bet: Compute@Edge.
The edge computing technology, still in the testing phase, will allow customers to create near real-time dynamic and personalized internet services and applications that will run on Fastly's data centers. And to offer better performance and flexibility, the company developed its own serverless technology (the misleading term "serverless" means cloud infrastructures and servers provide resources to applications on an as-needed basis).
Yet Fastly's demanding valuation indicates the market expects flawless execution over the long term, which includes the success of its new Compute@Edge platform. That doesn't leave much margin of safety, and the stock may now be too risky, even for audacious investors.