The content delivery network (CDN) specialist Fastly (NYSE:FSLY) has announced that it agreed to acquire the cybersecurity outfit Signal Sciences last week in a cash and stock transaction. Here's why this deal should get Fastly shareholders excited.
Synergies with cybersecurity
With its presence in 55 markets around the world, Fastly delivers computing infrastructure closer to end users to accelerate access to internet resources. For instance, Fastly provides services to TikTok, which means TikTok users enjoy fast access to the social media platform without knowing Fastly is working behind the scenes.
In addition to these CDN capabilities, the company is developing its Compute@Edge offering, which will allow its customers to offer personalized and decentralized services without compromising performance and security. For example, Fastly's customers will be able to develop applications that comply with local rules depending on where their users are located.
As Fastly's solutions sit between users and computing infrastructures that deliver internet services, cybersecurity represents a key element of its portfolio. The company already offers its web application firewall to prevent hostile traffic from reaching websites, and its authentication capabilities control and secure user access.
With the Signal Sciences deal, Fastly will accelerate the development of its cybersecurity portfolio. For instance, Signal Sciences' bot mitigation solution prevents malicious activities on websites, and its API (application programming interfaces) protection capabilities manage access to companies' resources that partners use for project development.
During a call related to the acquisition, management announced it will integrate Signal Sciences' technology in the Compute@Edge platform. That decision makes sense: Beyond the synergies between both companies' solutions, Fastly will become a stronger competitor against innovative CDN and edge computing specialists such as Cloudflare (which has been providing edge computing and security capabilities for a couple of years).
The financial aspect
Fastly agreed to pay $775 million for the acquisition -- a significant amount relative to its scale. In addition, it offered $50 million in restricted stock to retain Signal Sciences employees. By comparison, Fastly generated $75 million of revenue during the second quarter, up 62% year over year, and it has yet to become profitable. Also, cash and equivalents amounted to only $384 million at the end of the last quarter.
Including the $50 million retention pool for Signal Sciences employees, the price of the transaction corresponds to nearly 30 times Signal Sciences' $28 million annual recurring revenue at the end of June. That represents a steep price, even in the context of the company's strong growth. Management said Signal Sciences posted a "faster annual revenue growth rate" than Fastly during the second quarter.
However, Fastly will use its richly valued stock to finance a sizable part of the transaction, which is a smart decision that will help offset the deal's high price tag. Consideration will include $200 million of cash and $575 million of Fastly common stock.
And besides both companies' complementary technologies, Fastly can profit from cross-selling opportunities. It will get direct access to more than 40 Signal Sciences' enterprise customers (those with revenue in excess of $100,000 over the last 12 months) that it doesn't serve yet -- Fastly had 304 enterprise customers in the second quarter.
Also, Signal Sciences' gross margin was more than 85% during the last quarter, which will help Fastly boost its own profitability (gross margin of 60.2% in the latest quarter).
Thus, despite the steep price to acquire Signal Sciences, the deal seems to make sense for Fastly from a financial perspective.
An important part of the investment thesis in Fastly depends on the growth engines that Compute@Edge and cybersecurity will represent over the long term. Thus, this large transaction, which is expected to close this year, should reassure shareholders that those growth drivers will be well positioned going forward.