Fastly stock drops 20% as analysts weigh in on how TikTok may affect the edge-computing platform’s growth

Fastly Inc. shares pulled back from their recent lofty heights Thursday, as analysts weighed in on how the popular video-sharing platform TikTok will affect the edge-computing platform’s growth as more businesses migrate functions to the cloud.


shares fell as much as 21% Thursday, and were last down 17% at $90.40, on volume of more than 23 million shares, compared with a 52-week average daily volume of 3.4 million shares.

Late Wednesday, Fastly reported quarterly results and an outlook that topped Wall Street estimates, but revealed that TikTok was the company’s single largest customer, accounting for 12% of revenue. Fastly is a so-called “edge-based” cloud-computing platform that allows developers to get the best possible performance from their applications.

TikTok has come under fire from President Donald Trump, who has suggested banning the service as a national-security risk because of ownership by the Chinese company ByteDance. Trump has also suggested that the U.S. Treasury should get a cut of the purchase price if TikTok is acquired by Microsoft Corp.
Also of note, organized TikTok users were credited with helping to wildly inflate attendance expectations of Trump’s ill-attended Tulsa, Oklahoma rally back in June.

Even with Thursday’s drop, Fastly shares have soared 324% from their opening on the New York Stock Exchange in May 2019, with shares skyrocketing 294% in the past three months. In comparison, the tech-heavy Nasdaq Composite Index

has gained 25% in the past three months, and the S&P 500 index

has risen 17%.

Oppenheimer analyst Timothy Horan downgraded Fastly to perform from outperform and said TikTok was a “major risk” to the elevated stock price.

“A TikTok ban in the U.S. could prevent FSLY from hitting 3Q/FY20 guidance,” Horan said. “TikTok is FSLY’s largest customer and is likely ~15% of revenues in 1H20, with about half that generated in the U.S. We do think a TikTok/ MSFT deal is far from certain, and long-term MSFT could move TikTok delivery on its own edge infrastructure.”

For the third quarter, Fastly forecast an adjusted loss of a penny a share to net income of a penny a share on revenue of $73.5 million to $75.5 million. Analysts, who had previously forecast a loss of 4 cents a share on revenue of $72 million on average, now expect earnings of a penny a share on revenue of $74.8 million.

Read:Facebook’s TikTok rival comes as Chinese company’s future is in limbo

William Blair analyst Jonathan Ho, who has an outperform rating on the stock, said weakness could make a good entry point given its recent performance, even with a possible U.S. ban of TikTok.

“Third-quarter guidance calls for sequentially flat revenue growth, which appears conservative but also reflects some unknowns around TikTok and continued COVID-19-driven demand as global economies reopen,” Ho said. “Fastly remains a stock we would want to own given broader themes around digital transformation and edge compute, and we would take advantage of weakness in the shares.”

Raymond James analyst Robert Majek, who rates the stock as market perform, said TikTok “remains a double-edged sword” for Fastly.

Majek said one “area of perceived softness” in Fastly’s results was slowing growth in its large enterprise customers, which could reflect a COVID-19 related pullback in spending, but noted the addition of a very significant customer.

“We note that the gross adds included one very meaningful customer, Amazon
which we believe is using Fastly to deliver ~90% of its image content across the 20 global cities we tested,” Majek said.

Stifel analyst Brad Reback, who has a buy rating and hiked his price target to $98 from $30, noted that while 12% of Fastly’s revenue came from TikTok, half of that came from outside of the U.S., and that digital transformation trends, prompted by COVID-19 adaptation, would drive more organizations to “re-platform their applications” using Fastly.

“The banning of the app in the US would create short-term uncertainty around Fastly’s revenue contribution from ByteDance; however, management believes it has the ability to backfill the majority of this potentially lost traffic,” Reback said.

Of the 11 analysts who cover Fastly, five have buy or overweight ratings, four have hold ratings, and two have sell ratings, and an average target price of $93.25, according to FactSet data.

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Fastly: Accelerating Growth And Strong Upside Potential (NYSE:FSLY)

The current economic scenario carries lots of uncertainties for investors, but a few select businesses are benefitting from increasing demand in these unprecedented times. Fastly (FSLY) is delivering accelerating growth during the pandemic, and the company offers abundant potential in the years ahead.

Accelerating Revenue Growth

Fastly provides a Content Delivery Network (CDN) on an edge cloud platform. In essence, the company is in the business of making the internet faster and more secure. In times of global pandemic and shelter at home policies all over the planet, it is more important than ever to keep the internet running smoothly and safely.

The technology can be complex, but the company’s mission is quite straightforward:

“Our mission is to fuel the next modern digital experience by providing developers with a programmable and reliable edge cloud platform that they adopt as their own.”

Fastly counts among its customers many of the most successful and renowned internet players in the world, including names such as Shopify, Yelp, Twitter, Spotify, New York Times, Airbnb, and Vimeo, among many others.

Source: Fastly

Management considers that its market opportunity is large and growing. The company estimates that the total addressable market opportunity could be worth around $18 billion in 2019 and growing to $35.8 billion by 2022.

These kinds of estimates from management necessarily carry a large degree of error and should always be taken with a grain of salt, especially in an uncertain economic environment. However, the financial reports for the first quarter of 2020 confirm that Fastly is benefitting from accelerating growth and the business looks stronger than ever during challenging times for the global economy.

Total revenue during the first quarter of 2020 reached $63 million, an increase of 38% year-over-year. Dollar based net retention rate was 133% during the quarter; the net retention rate – which includes the impact of churn rate – was 130%. This is indicating that customers continue to spend more with Fastly, which is a positive reflection on the company’s ability to deliver value to those customers.

In a sign of confidence, management also raised guidance for the full year 2020. Fastly increased revenue guidance to the range of $280 million to $290 million from $255 million to $265 million.

Management highlighted during the conference call how the social distancing measures have produced an acceleration in demand over the short term, but the company’s growth engines are ultimately supported on long-term drivers.

In the words of CEO Joshua Bixby:

“As social distancing measures increased over the March period, we continue to see increased traffic across the internet and our platform, which certainly provides an additional boost to our results, but more than anything our first quarter results were driven by Fastly’s strong business fundamentals and the quality of our offerings, which we believe will continue to attract the best of the web.

Fastly is a platform of choice for innovators. We are partnering with the most technologically advanced and creative companies who we believe will not only weather this storm, but will continue to thrive in this environment. Companies are increasingly recognizing the importance of digital transformation, not only to survive during these uncertain times, but also for long term success. As we’re seeing this trend accelerate and evolve, we believe we are best positioned to partner and grow with these companies as they look for a trustworthy and modern platform.”

The company is making a big bet on serverless computing with its Compute@Edge offering, which is still in beta and moving to limited availability. This new business could be a powerful growth engine and a major source of competitive strength for Fastly, and it will probably have a positive impact on the company’s profit margins over the medium term.

Risk, Timing And Valuation

Fastly’s most attractive growth opportunities come from edge computing solutions. The company has outstanding technologies in this area, but it also faces competition from companies such as Cloudflare (NET), Akamai (AKAM), Microsoft (MSFT), and Amazon (AMZN).

Wall Street analysts generally have a simplistic view of competitive dynamics. Only because a company has competition from large rivals does not mean that it will be crushed by such competition. On the contrary, a smaller and deeply focused player can many times deliver more innovative solutions with superior speed and flexibility than larger rivals. Besides, when the market opportunity is large and growing, it can provide enough room for multiple successful players to do well in the long term.

But it will be very important to watch the competitive dynamics in the industry over the medium term, because this is arguably the biggest risk being faced by investors in Fastly’s stock. If the company fails to keep its technological edge over the competition with permanent innovation, then the whole bullish thesis for Fastly falls apart.

Fastly is also losing money at this stage. The company is clearly making progress in this area, and management is confident about the prospects for reaching profitability in the medium term, but this still remains to be seen.

The timing can seem tricky at first sight. The stock has been moving sideways over the past several months, and then it made an explosive move to new highs after reporting much better than expected earnings and increased guidance last week.

However, make no mistake, it is not too late to buy Fastly. If the company continues growing well and gaining market share versus the competition, the stock has plenty of room for upside potential from current levels.

The table shows some key statistics for Fastly versus Akamai and Cloudflare. To begin with, Fastly is materially smaller in terms of both revenue and market capitalization, so it has a lot of room to gain size if the company continues delivering solid performance over time.

Besides, the price to sales growth – which is calculated by dividing the price to sales ratio by the revenue growth rate – is lower in the case of Fastly than in Akamai or Cloudflare.

Market Capitalization 3,465.60 15,466.82 8,454.56
Revenue Trailing 12 Mo 217.83 2,951.41 316.55
Sales Growth TTM 38.20% 7.24% 48.91%
Sales Growth 38.20% 7.24% 48.91%
Price to Sales 16.01 5.29 26.07
PSG 42 73 53

Data from S&P Global via Portfolio123

There are many things that could go wrong with Fastly, but valuation should be no impediment for the stock to deliver solid returns if the company’s fundamentals remain strong.

The Bottom Line

When you find a company with high growth prospects and still at a relatively young age, the risks are always substantial, especially in a business operating in a highly dynamic landscape and facing intense competition. In this particular case, competitive pressure first, and lack of profitability a distant second, are the main risk factors to watch.

Even if the stock is trading at new highs, valuation should not be a problem as long as the business keeps growing well. Fastly is still relatively small, and the stock price is not excessive at all in comparison to the company’s growth opportunities.

Besides, the company is run by a leadership team with plenty of skin in the game and a solid track record of delivering consistent growth and innovation over the years. This reinforces the idea that Fastly will be able to stay nimble and continue delivering the right solutions to its customers over time.

Fastly has a lot of room for sustained revenue growth and expanding profitability over time. In such a scenario, increasing sales and a larger share of revenue being retained as profits could provide a double boost to earnings growth over time.

In a nutshell, Fastly is a high-risk investment, no doubt about that. But upside potential could more than compensate for the risk if things work out well for investors over the years ahead.

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Performance as of May 15, 2020

Disclosure: I am/we are long FSLY, AMZN. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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