Is Fastly Stock a Buy?

Fastly (FSLY -0.47%), a provider of cloud-based services for edge networks, went public last May. The company dazzled investors with its robust revenue growth, and its stock subsequently surged nearly eightfold from its IPO price of $16. But is Fastly still worth buying after that massive rally? Let's dig deeper into its business model, growth rates, and valuations to find out.

What does Fastly do?

Websites, apps, and services are hosted on "origin" servers around the world. However, the speed of an origin server is limited by its physical proximity to a user and its overall capacity.

Image source: Getty Images.

To address those weaknesses, companies often rely on "edge" servers located closer to users to reduce the strain on their origin servers. Fastly's cloud platform helps companies "build, secure, and deliver digital experiences" on those edge servers.

Fastly's platform bundles together a content delivery network (CDN) for digital media, load balancing tools, cybersecurity services, bot blockers, and other services. It's already used by companies like e-commerce services provider Shopify, streaming music giant Spotify, and digital payments company Stripe.

How fast is Fastly growing?

Fastly's revenue rose 38% in 2018 and 39% in 2019, and grew 50% year-over-year to $137.6 million in the first half of 2020. It attributed that acceleration to the surging usage of online services throughout the COVID-19 crisis, as more people worked from home, bought more products online, and streamed more media content.

Fastly's net retention rate, which gauges its ability to retain customers and gain new ones, rose from 130% in the first quarter to 138% in the second quarter. Its dollar-based net expansion rate, which measures its revenue growth per existing customer, rose from 133% to 137%.

Those growth rates indicate Fastly excels at locking in customers and cross-selling additional services. Its total customer count also grew 6% sequentially to 1,951 in the second quarter, marking its strongest quarterly growth since its IPO.

304 of Fastly's customers are large enterprise customers, which generated 88% of its revenue over the past 12 months. Its average revenue per enterprise customer rose from $642,000 in the first quarter to $716,000 in the second quarter. Its top customer in the first half of 2020 was notably ByteDance's TikTok, which accounted for 12% of its total revenue.

Fastly expects its revenue to rise 48%-52% year-over-year in the third quarter, and 45%-50% for the full year. Analysts expect its revenue to rise 48% this year and 33% next year.

But don't ignore the weaknesses

Fastly's growth is impressive, but it remains unprofitable. Its net loss widened from 2018 to 2019, and widened again year-over-year from $25.3 million to $26.5 million in the first half of 2020. It doesn't expect to turn a profit anytime soon.

Fastly also faces a growing number of competitors in the edge computing market. Amazon (AMZN -1.64%) Web Services (AWS), the world's largest cloud infrastructure platform, is expanding its Cloudfront and Lambda services onto edge networks.

Older CDNs, like Akamai (AKAM 0.42%), Limelight (EGIO -9.23%), and Imperva, are also expanding their edge networking services. Small-business CDNs like Cloudflare (NET -0.23%) could also start eyeing Fastly's core market of large enterprise customers.

Fastly's dependence on TikTok is another soft spot. A court recently blocked the Trump Administration's proposed ban on the popular short video app, but only with a temporary injunction. TikTok could remain active in the U.S. if its Chinese parent company finalizes a proposed investment deal with American companies, but it could also be abruptly shut down.

Last but not least, Fastly's stock looks expensive at nearly 50 times this year's sales. Here's how its valuation and growth rate stacks up against its aforementioned CDN rivals:

Source: Yahoo Finance, Oct. 12.

The bulls might claim Fastly deserves its premium valuation, but the stock is arguably priced for perfection at these levels.

Is it too late to buy Fastly?

Fastly enjoys an early-mover's advantage, it's growing rapidly, and its ecosystem is sticky. Unfortunately, its lack of profits, competitive threats, exposure to TikTok, and frothy valuation all prevent me from buying the stock. For now, I'll add Fastly to my watchlist of high-risk stocks instead of pulling the trigger.