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Why Fastly Stock Is Still Too Pricey

By Herve Blandin - Feb 24, 2021 at 8:15AM

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Management communicated underwhelming full-year guidance.

Fastly's (FSLY -1.43%) stock price has plunged more than 35% since Feb. 9, partly because of the underwhelming full-year 2021 guidance management communicated last week in its fourth-quarter earnings report.

Does that mean investors should avoid the stock? Or should they take advantage of this short-term volatility to invest in the innovative content delivery network (CDN) specialist?

Fastly hit by decelerating revenue growth

The company's CDN business is poised to grow over the long term. Indeed, enterprises are digitizing, and Fastly accelerates access to online services by leveraging its infrastructure across 26 countries to host content closer to users, a service called edge computing.

Cloud icons in server room

Image source: Getty Images.

In addition, Fastly keeps innovating to propose differentiating offerings and boost revenue growth over the next several years. For instance, its new edge computing Compute@Edge platform allows customers to create dynamic content at the edge of its network to enable rapid access to personalized online services. It's also enhancing its portfolio with cybersecurity features by integrating the technology of the cybersecurity specialist Signal Sciences, which it acquired last year.

As a result, revenue grew 40% year over year to $83 million during the fourth quarter, boosted by existing customers who spent 43% more than the year before, as evidenced by the dollar-based net expansion rate of 143%.

However, that apparently strong revenue growth is showing signs of weakness. If you exclude approximately $6 million of extra revenue contribution from Signal Sciences, Fastly's revenue growth decelerated to 30% year over year, down from 44% in the prior-year period.

Looking forward, management expects full-year revenue to land in the range of $375 million to $385 million, which corresponds to a 31% year-over-year growth at the midpoint. But similarly, if you assume approximately $35 million of contribution from Signal Sciences in 2021, as discussed by an analyst during the earnings call, Fastly's top-line growth will decelerate to only 21%, compared to 45% in 2020.

Granted, Signal Sciences will enable cross-selling opportunities with Fastly's core offerings, and taking revenue from the combined entities into account makes sense. But you should also keep in mind that Fastly's decelerating revenue growth seems worrying, given the company's modest scale relative to the huge $35.4 billion market opportunity management estimated by 2022.

Besides, despite its larger scale, competitor Cloudflare (NET 1.87%) posted stronger results and guidance a few days ago. During the fourth quarter, revenue increased by 50% year over year to $126 million, and CFO Thomas Seifert anticipates revenue to grow by 37% to 38% in 2021.

Challenges ahead for Fastly

In particular, Fastly met challenges in increasing its large-customer count. During the last quarter, the number of customers who spend at least $100,000 over the last 12 months increased by only 11 quarter over quarter, to 324. In contrast, Cloudflare added 92 large customers during the same timeframe for a total of 828.

That modest addition of large customers may be the result of Fastly's reduced offering, compared to the broad set of CDN and cybersecurity solutions Cloudflare and Akamai Technologies (AKAM 1.07%) offer. Granted, Fastly is expanding its edge computing and cybersecurity capabilities, but execution risks exist. For instance, Compute@Edge won't generate any meaningful revenue before 2022 as customers are still exploring the possibilities the new technology offers.

Fastly will also be facing intensifying competition with its growth initiatives in the edge computing and cybersecurity markets. For instance, the legacy tech player F5 Networks acquired Volterra in January to develop edge computing capabilities as a service. The tech giant Cisco Systems partnered with Qwilt in October 2020 to offer video streaming edge computing capabilities. And the legacy CDN player Akamai Technologies announced last week that it will be focusing on cybersecurity and edge computing going forward. 

Identifying the winners in such a competitive and innovative environment remains difficult, but the intensifying competition will certainly represent headwinds for Fastly's revenue growth.

Fastly is still too pricey

Considering the company's challenges, the negative market reaction following management's underwhelming revenue guidance makes sense. Yet the stock is still trading at a forward enterprise value-to-sales ratio of 27, which remains elevated given Fastly's decelerating revenue growth in its increasingly competitive environment.

Thus, investors should wait for a stronger pullback before considering buying the tech stock. If you're looking to invest in growth opportunities, you should instead take a look at these three top growth stocks.

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Stocks Mentioned

Fastly, Inc. Stock Quote
Fastly, Inc.
FSLY
$11.76 (-1.43%) $0.17
Akamai Technologies, Inc. Stock Quote
Akamai Technologies, Inc.
AKAM
$98.55 (1.07%) $1.04
Cloudflare, Inc. Stock Quote
Cloudflare, Inc.
NET
$56.73 (1.87%) $1.04

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