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Why Investors Are Paying a Premium for Fastly

By Herve Blandin – Jul 23, 2020 at 10:15AM

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Cybersecurity and edge computing should fuel the content delivery network specialist's revenue growth over the next several years.

After gaining more than 600% from its March lows, content delivery network (CDN) provider Fastly's stock is trading at 39 times trailing-12-month sales despite having yet to report a profitable quarter. With that rich valuation, the market values the company at a premium to its competitors, too. Here's why investors are paying such a steep price for Fastly stock. 

A lofty valuation

Fastly implemented a network of data centers around the world to process data closer to end-users and accelerate the performance of online services. Customers such as the e-commerce specialist Shopify and the social network Twitter use Fastly's computing infrastructure to improve user experience.

IT technician with a laptop and engineer are talking in data center while walking next to server racks.

Image source: Getty Images.

Management estimates the CDN and streaming markets Fastly addresses will reach $17.5 billion by 2022. However, the company hasn't developed yet any scale advantage against CDN giant Akamai Technologies and some of its smaller competitors Cloudflare and Limelight Networks, based on their respective last-quarter revenue.

Company Last-Quarter Revenue
Fastly (FSLY -4.76%) $62.9 million
Akamai Technologies  $764.3 million
Cloudflare  $91.3 million
Limelight Networks  $58.5 million

Data sources: Fastly, Akamai Technologies, Cloudflare, and Limelight Networks.

In addition, Fastly's modest gross margin -- 56.7% during the last quarter -- seems to indicate the company is not in a position to profit from pricing power. Of the three competitors listed in the table above, only Limelight Networks has been posting lower gross margins as it competes for enterprise customers based on price (but Limelight Networks compensates its weak gross margins with lower operating expenses as a percentage of revenue to address fewer but larger customers).

Yet despite its reduced scale and low gross margins, the market values Fastly stock at a premium to its competitors after its impressive rally from its March lows, with a lofty enterprise value-to-sales ratio close to 39.

FSLY Revenue (Quarterly YoY Growth) Chart

FSLY Revenue (Quarterly YoY Growth) data by YCharts

Fastly stock certainly deserves a higher revenue multiple compared to Akamai Technologies and Limelight Networks thanks to its higher revenue growth. But such a significant valuation gap reflects demanding expectations from the market.

Edge computing and cybersecurity as growth engines

Shelter-in-place orders boosted Fastly's business as they accelerated the consumption of internet services during that period. But they also benefited its competitors.

Yet the company differentiates itself from its competitors by developing its technologies to give more control to developers and offer better performance. As CEO Joshua Bixby likes to repeat: Fastly proposes a "system built by developers for developers."

CDN providers are rushing to propose innovative edge computing solutions that allow the development of dynamic applications on their infrastructures. With its new product [email protected], Fastly proposes its own technology, Lucet, to optimize performance and security. In contrast, Cloudflare has chosen off-the-shelf products such as Chromium's V8 engine for its edge computing offering, at the cost of potentially lower performance.

In addition, Fastly plans to boost its cybersecurity portfolio to take advantage of cross-selling opportunities with its CDN offering.

These edge computing and cybersecurity activities should expand Fastly's total addressable market to $35.4 billion by 2022, according to management. And such value-added propositions should improve operating margins, which would drive Fastly closer to profitability (last quarter, management forecasted non-GAAP (adjusted) full-year operating losses will land in the range of $10 million to $20 million).

The market values Fastly at a premium thanks to the following assumptions:

  • The company addresses a growing market over the long term
  • It will expand its addressable market and gain market share with its differentiated edge computing and cybersecurity solutions
  • It will improve its margins -- and become profitable -- with scale and higher-value services

A justified premium?

Investors should remain prudent, though. As a growth stock, Fastly certainly deserves a rich valuation. But it remains to be seen whether the CDN specialist can sustain a competitive advantage over the long term despite its modest scale.

Investors should closely monitor the success of the company's cybersecurity and [email protected] initiatives over the next several quarters before paying for such a premium.

Herve Blandin has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Fastly, Shopify, and Twitter. The Motley Fool has a disclosure policy.

Stocks Mentioned

Fastly Stock Quote
$9.21 (-4.76%) $0.46

*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.

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