After peaking at over $100 earlier in July, sellers pulled Fastly (NYSE:FSLY) shares down to below the $80 level. Last week, FSLY stock rose by over 20% ahead of its earnings report scheduled for August 5, after the market closes.
Why are investors so enamored with this application software company? Last quarter, Fastly posted revenue of $62.9 million. Analysts expect revenue to rise to $71.45 while it will lose a penny a share.
FSLY Stock Up Since Q1 Report
Fastly’s Dollar-Based Net Expansion Rate (DBNER) rose 133%. This is a company-specific metric that no other firms use. If customers stay for over a year, then their revenue counts. The net retention rate of 130% year-over-year (Y/Y) includes churn. These figures illustrate a correlation between users trying out the product against those who become paying customers.
CEO Joshua Bixby said, “When you look at our DBNER, the new stat that we brought out around net retention, what you see is that when customers try us, they see – you know they haven’t – they see a new world.” He said that the faster, more secure, and scalable platform “is a platform from which you can’t go back, and so I think one of the things that we see in these disruptive times is people taking risks and innovating.”
No wonder investors are willing to pay over 45 times revenue.
Fastly’s revenue grew 38% to $63 million last quarter but it still lost 12 million (on a GAAP basis), up from a loss of $8 million last year. Investors are speculating that as the company adds more customers, their loyalty will increase gross margins and lead to sustainable profits ahead. Fastly may lower capital expenditures in the future. This would allow it to post profits.
Strategically, increasing capex as a percentage of revenue would pay off in the longer-term. This would further differentiate its offering from competitors. For example, the CEO cited one of the biggest e-commerce platforms coming as a Fastly customer. The more customers of this size, the faster the revenue growth. Eventually, the price-to-sales multiple will shrink.
Seven Wall Street analysts have an average one-year price target of $67.33 (according to Tipranks). This is a 30% downside forecast for FSLY stock. By comparison, in my 5-year discounted cash flow revenue exit model, shares have a fair value of $86.43. That is a downside risk of 10%.
These are the metrics used in the DCF model:
|Discount Rate||11.0% – 10.0%||10.50%|
|Terminal Revenue Multiple||17.6x – 18.6x||18.1x|
|Fair Value||$82.36 – $90.64||$86.43|
The global pandemic sped-up the need for customers to seek edge cloud platform services. Everything from video, a content delivery network, and streaming services are in very high demand. And because this trend will not end anytime soon, Fastly might raise its revenue guidance when it reports quarterly results later this week.
As Fastly expands its back-end bandwidth and hardware, it will increase capacity. As it wins more customers, revenue will grow. Operationally, its limited sales and technical hiring will constrain costs. Fastly should benefit from staff productivity because their interactions are done online instead of face-to-face.
Your Takeaway on Fastly Stock
Fastly is not a suitable investment for everyone. Investors who demand value will not want to pay the premium. A mild market correction will easily knock Fastly’s share price lower. Investors also have other companies to consider. Slack (NYSE:WORK), for example, is trading in a narrow range. Zendesk (NYSE:ZEN) shares are in an uptrend and went on sale last Friday when it fell 9.37% on the day.
Hold Fastly for now but get ready to sell it if others rush for the exit.
As of this writing, the author did not hold a position in any of the aforementioned securities.