Fastly (FSLY -0.47%) and Cloudflare (NET -1.05%) were promising edge computing start-ups following their respective IPOs in the spring and autumn of 2019. Fastly got off to the hotter start, with many praising the company's edge compute technology as the winner during the early days of the pandemic. However, the two companies' fortunes have diverged dramatically since then. Since the start of 2020, Fastly shares are up 97% -- but Cloudflare's up an incredible 596%.
There is plenty of overlap between these two small edge compute platforms, but the diversified business model has made a world of difference for Cloudflare. So is it still the better buy going forward?
Fastly tumbles again, but could still get back on its feet
Fastly's woes started over the summer of 2020, as it suffered collateral damage from the spat between TikTok and the Trump administration as well as the broader U.S.-China trade war. Fastly, which makes money when customers route internet traffic through its platform, ultimately lost some momentum when TikTok had to hit the brakes here in the States. It was a big customer, one that Fastly was going to need time to replace. And time has not been on the company's side lately.
Customer concentration is still a problem for this small edge-based content delivery network (CDN), and a service outage in early June 2021 caused a widespread shutdown of web-based services across many of its users for nearly an hour. Fastly said the outage was caused by a valid configuration change from one of its customers that triggered an undiscovered networking bug, and the glitch was quickly fixed. Nevertheless, during the company's Q2 2021 earnings update, it revealed that it's still trying to restore traffic volume from its top users (Fastly has competition, so it seems some large customers have rerouted traffic elsewhere).
As a result, management's full-year 2021 revenue guidance now calls for a range of $340 million to $350 million (previously $380 million to $390 million), a mere 19% year-over-year increase at the midpoint (down from 45% growth in 2020) in spite of additional sales from the acquisition of cybersecurity outfit Signal Sciences last year. Nevertheless, edge computing is still early in development, and Fastly is steadily adding new customers to diversify its business. It remains a leader on this front as internet-connected services proliferate around the globe.
The company has ample liquidity, with cash and investments of $1.1 billion offset by debt of $931 million. At 14 times expected 2021 sales, the stock isn't exactly cheap, but perhaps a long-term value if the company can get back on its feet next year.
Cloudflare's massive user base is a key differentiator
While Fastly reports having just shy of 3,000 total paying customers, with a large amount of revenue being derived from its top-10, Cloudflare has an entirely different business model. It has over three million users, most of them using Cloudflare services for free. Of the massive following this outfit has accumulated, over 126,000 are paying users, and its large enterprise subscriber count is only just getting rolling. At the end of Q2 2021, Cloudflare reported just 1,088 customers that spend at least $100,000 per year.
This highly diversified business model that mixes free-to-use services with premium access for larger and more complex users has paid off in spades. Fastly has faded as it begins to lap the boom in internet traffic that started last spring, but Cloudflare's results have been more and more positive. Q2 revenue was up 53% year-over-year, up from the 51% rate in Q1 and the 50% growth reported in all of 2020. Full-year expectations were recently upgraded and now imply a year-over-year expansion of no less than 46% over 2020. All of that is organic growth, too, as Cloudflare hasn't made any splashy acquisitions in the last year to boost sales.
As more large organizations make use of edge computing, the sky's the limit for Cloudflare. Granted, a lot of this wide-open space for expansion with larger customers is already priced in. Though expected revenue for 2021 is not quite double what Fastly is forecasting, Cloudflare's market cap is over $37 billion, compared to Fastly's $4.8 billion. That values Cloudflare at a whopping 59 times expected 2021 sales -- an incredibly "expensive" premium by any measure.
However, part of this premium is well deserved. Cloudflare is knocking on the door of free-cash-flow-positive territory, although it fully expects to reinvest excess cash to maximize growth for the foreseeable future. It also has a strong balance sheet, with $1.03 billion in cash and equivalents and convertible debt of only $401 million.
Which is the better edge computing stock?
Fastly looks like a more timely purchase right now. The bad news has been piling up for a year now, and shares have fallen precipitously from all-time highs. A big rebound in its stock price could be in order if the company can manage an acceleration in its revenue trajectory going forward.
Nevertheless, Cloudflare has made some serious hay in the last year. Its massive user base, steady addition of large new customers, profitable operation, and strong balance sheet clearly favor its long-term dominance in the edge computing race.
But I can't emphasize "long-term" enough. With a steep premium, volatile share price action is inevitable. Don't expect a repeat of the nearly-600% gain since 2020 anytime soon. However, if you're eyeing a great way to bet on the edge computing movement for the next decade and beyond, Cloudflare is in tip-top shape.