Fastly: Fear Creates Opportunity (NYSE:FSLY) (2024)

Shares of Fastly (NYSE:FSLY) were down 30% after the cloud-edge computing company reported results for its first-quarter and disappointed the market with a weak revenue forecast for Q2'24. The market very likely overreacted to the company's top-line outlook, in my opinion, and with a promising margin trend, I believe investors have been overly focused on the negatives in Fastly's earnings report. With growing GAAP margins and still double-digit top-line momentum expected for FY 2024, I believe the value proposition is better than investors think it is, especially for long-term investors that have a stomach for price volatility.

Previous rating

I upgraded shares of Fastly to buy in my last work on February 15, 2024 -- 3 Reasons Why I Am Buying The Drop -- as the company was moving closer to GAAP profitability and free cash flow losses were narrowing. The revenue outlook for the second-quarter was a bit weak, but didn't justify, in my opinion, the loss of about one-third of the company's market cap on Wednesday. Fastly is seeing positive trends in its business, including a growing customer base and increasing GAAP margins, which I believe support the buy-case as well as a rating upgrade.

Solid platform growth, but weak outlook weighs on shares

Fastly delivered its earnings report for the first-quarter on Wednesday, with the cloud-edge computing company beating adjusted EPS estimates by $0.01 per-share. Fastly generated $133.5M in revenues in the first-quarter (which missed estimates by $350k), but the company is still growing. The year-over-year growth rate in Q1'24 was 14% and the company generated higher GAAP (and non-GAAP) margins as well. In the first-quarter, Fastly's non-GAAP gross margin -- a key metric to evaluate the company's profitability and efficiency -- hit 58.8%, showing an improvement of 3.2 PP year over year.

Fastly's enterprise customer count declined by one customer in Q1'24 and the cloud-edge computing company ended the March quarter with 577 enterprise customers on its platform. However, the company more than offset this decline with growth in its non-enterprise customer portion. Total customers, at the end of Q1'24, totaled 3,290, showing a net customer addition of 47 quarter over quarter.

Fastly's customer base is still growing, and the company achieved its fourth straight positive adjusted EBITDA in the first fiscal quarter, in the amount of $3.7M. The positive adjusted EBITDA trend, together with improving (non)-GAAP margins as well as an expanding customer base, in my opinion, provide support for the buy thesis here.

Revenue forecast leads to price plunge

While Fastly's results were overall slightly better than expected and showed promise in terms of margin development, the revenue outlook for the second-quarter is what caused the share price to tank 30% after-hours, which, in my opinion, was not deserved. Fastly guided for $130-$134M in revenues for Q2'24 which implies a potential Q/Q drop of up to 2.6%. However, on a full-year basis, Fastly expects $555-565M in revenues, implying a year-over-year growth rate of 11%, so the company is still going to grow, just not as fast as expected. Of course, this change in outlook has caused a revaluation of the company's multiplier, but I believe investors are overly bearish now, creating an entry opportunity for growth investors.

Fear creates engagement opportunity

Fastly is now trading at a 30% discount compared to its pre-earnings valuation, and I believe that the market is hopelessly overreacting here. Fastly's revenue outlook for Q2'24 was a disappointment, but the full-year forecast still implies a solid 11% top-line growth rate. Currently, shares of Fastly are valued at 2.6X FY 2025 revenues and estimates for sales are likely to get reset to the downside following the Q1'24 earnings report.

For FY 2025, I want to err on the cautious side and assume that Fastly will only grow its revenues by 10% which implies a forward revenue volume of $620M. Fastly has a post-selloff market cap of $1.2B, which implies a price-to-revenue ratio of 1.9X… well below the 5.5X P/S average in the last three years. In my opinion, investors are now fundamentally driven by fear, which creates a unique investment opportunity for growth investors.

My fair value P/S ratio has not changed and remains at 4-5X, which implies a fair value market cap of $2.5-3.1B. This translates to a fair market price for Fastly's shares of $19-23 (down from my previous range of $22-26 per-share).

Risks with Fastly

The biggest risk is indeed a slowdown in Fastly's revenue growth rate. As a cloud-edge computing company, Fastly is chiefly evaluated based off its prospects for revenue growth, so a moderation of top-line growth would give investors a good reason to apply a lower valuation factor to the company's revenue base. What would change my mind about Fastly is if the company failed to make steady progress toward GAAP profitability or if its margin trend reversed.

Final thoughts

The market's reaction to Fastly's first-quarter earnings is completely overdone. Yes, the Q2'24 revenue forecast was not great and showed a potential Q/Q drop, but the full-year revenue outlook is still very much respectable. Fastly's total customer base is also expanding and the cloud-edge computing platform sees improving GAAP/non-GAAP margins, indicating that the company's monetization is improving. Shares of Fastly lost about one-third of their market value on Wednesday, which seems a bit excessive. I believe investors have become too fearful here, which creates an entry opportunity for those investors that can handle a bit of short-term volatility. Fastly's valuation also has become much more attractive, which in turn skews the risk profile to the upside.

The Asian Investor