Fastly (NYSE:FSLY) stock has risen almost 300% since May 1. It started at a per-share price of $21. FSLY stock opened this morning at just under $81. But unfortunately, the company has no real chances of making a profit or generating positive free cash flow.
Fastly is a content delivery network (CDN) that provides cloud cache services to corporate customers to speed up the delivery of internet data to their clients.
The problem is this is not especially profitable for Fastly. It really has no moat. According to one Seeking Alpha analyst, Fastly prices its CDN services lower than its competitors.
As a result, the company has never made a profit. It also has not yet been free cash flow positive. This is pretty rare for most internet and software companies. To me, it indicates that the business model is not that powerful.
But FSLY stock has risen because internet traffic and corporate website traffic has risen thanks to novel coronavirus lockdowns. The market assumes that higher revenue will lead to higher profits for the company. But this may not be the case.
Analyst Predictions for Fastly
According to a Yahoo! Finance poll of 11 analysts, the company will lose 13 cents per share this year and 4 cents next year. However, this is much better than last year when it lost 52 cents per share.
Moreover, revenue this year is expected to rise to $287 million from $200 million last year. In fact, next year’s sales estimates are 30% higher — up to $373 million.
A Seeking Alpha poll of 10 analysts for Fastly has roughly similar estimates.
So, in the space of two years, revenue almost doubles, but the company is still not expected to make a profit. That is not good. It implies that the margins are way too low. And that means that the company really cannot price its products and services high enough because of competition.
Analysts and journalists all take note of the company’s fast growth rate, especially with the explosion in digital media content apps. Bloomberg called it a “behind-the-scenes enabler of media consumption.”
It’s All About the Free Cash Flow
The problem is that the company’s free cash flow has not progressed as well as its revenue growth. For example, in the past year through March 31, 2020, the company’s free cash flow was negative $49.2 million.
That was with revenue in the last 12 months (LTM) at $217.8 million. This revenue was $17.3 million higher than in December 2019. But here is the problem. FCF for the last 12 months was better than the March LTM number. It was negative $45.9 million.
Again, here is the point: With higher revenue, Fastly had worse FCF generation. Whether that will continue is not clear. But I suspect that FCF improvement will likely not be as high as revenue growth. This is due to Fastly’s poor margin structure.
Valuation Issues With FSLY Stock
Let’s get real about how highly the market values Fastly. Right now, FSLY stock trades for 30 times this year’s expected revenue and 23 times next year’s. Those ratios are very high. They should be the ratios for price-earnings, not price-sales.
One analyst believes that Fastly’s valuation is not so bad compared to its rival, Cloudflare (NYSE:NET). He goes on to show that Fastly is cheaper than Cloudflare stock, which has even higher price-sales ratios. That is little comfort given that you can’t really spend comparative valuation ratios.
Here is the point. The market believes that the company will become very profitable sometime in the future. Otherwise, it would not have pushed the stock so high. But, so far, analysts have no estimates for Fastly profits in the next two years.
To put it bluntly, this is a momentum stock. It’s going up because it’s going up. Jump on the bandwagon. That’s all fine unless the band stops playing. You don’t want to buy this stock with a philosophy that you will sell it to the next greater fool.