1. Executive Summary
Fastly (FSLY) is a leading provider of edge cloud platform services, enabling businesses to accelerate the performance of their websites, applications, and streaming media. The company's core value proposition lies in its ability to deliver content closer to the end-user, thereby reducing latency, improving user experience, and enhancing security. This investment thesis centers on Fastly's strong technological foundation, its growing adoption among digital enterprises, and the substantial long-term growth potential of the edge computing market. Recent execution issues and customer concentration concerns have presented buying opportunities for investors willing to look beyond near-term volatility.
We believe that Fastly is poised to benefit from several key secular trends, including the increasing demand for real-time data processing, the proliferation of bandwidth-intensive applications (e.g., video streaming, gaming), and the growing emphasis on cybersecurity. While competition in the content delivery network (CDN) and edge computing space is intense, Fastly's developer-centric approach, its highly programmable platform (Compute@Edge), and its proven ability to serve demanding, performance-sensitive customers provide a competitive edge. We recommend a Buy rating, based on the expectation that Fastly will successfully execute on its growth strategy and capitalize on the expanding market opportunity. Our price target, based on a discounted cash flow (DCF) analysis, reflects the potential for significant upside as Fastly scales its operations and achieves sustainable profitability.
2. The Business Model
Fastly operates on a usage-based pricing model, charging customers based on the volume of data delivered, the number of requests processed, and the use of other platform services. Revenue is primarily derived from two main segments:
- Delivery Services: This constitutes the majority of Fastly's revenue and encompasses the core CDN services, including content caching, acceleration, and security features such as DDoS protection and web application firewall (WAF). Customers pay for the amount of data delivered from Fastly's edge servers to end-users.
- Compute@Edge: This is Fastly's serverless computing platform that allows developers to run code at the edge of the network. This service enables customers to build and deploy custom applications and logic directly on Fastly's edge infrastructure, opening up new possibilities for real-time data processing, personalization, and security. Customers are charged based on compute time, requests, and memory usage.
Fastly's business model is characterized by high gross margins, reflecting the inherent scalability of its software-defined network. The company invests heavily in research and development to maintain its technological lead and expand its platform capabilities. Sales and marketing expenses are also significant, as Fastly focuses on acquiring new customers and expanding its relationships with existing ones.
<DataTable type="financial_summary" ticker="FSLY" />3. Market Opportunity
The market opportunity for Fastly is substantial, driven by the growing demand for low-latency, high-performance content delivery and edge computing services. The total addressable market (TAM) for CDN and edge computing is estimated to reach hundreds of billions of dollars by the end of the decade. Key growth drivers include:
- Increasing Internet Traffic: The continued growth in internet usage, driven by the proliferation of connected devices and bandwidth-intensive applications, is fueling the demand for CDNs.
- Real-Time Data Processing: Applications such as online gaming, live video streaming, and IoT devices require real-time data processing and low latency, which can be effectively addressed by edge computing.
- Cloud Adoption: As businesses migrate their workloads to the cloud, they require solutions to optimize the performance of their cloud-based applications. CDNs and edge computing platforms provide a critical link between cloud infrastructure and end-users.
- Cybersecurity Threats: The increasing sophistication of cyberattacks is driving demand for security solutions that can protect web applications and infrastructure at the edge of the network.
- 5G Deployment: The rollout of 5G networks is enabling faster speeds and lower latency, creating new opportunities for edge computing applications that require high bandwidth and real-time performance.
Fastly's serviceable addressable market (SAM) consists of businesses that require high-performance content delivery and edge computing capabilities, including digital media companies, e-commerce retailers, SaaS providers, and financial institutions. The company is well-positioned to capture a significant share of this market, given its technological strengths and customer-centric approach.
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4. Competitive Moat
Fastly possesses several competitive advantages that contribute to its economic moat:
- Technological Leadership: Fastly's Compute@Edge platform is a significant differentiator, offering a highly programmable and flexible environment for developers to build and deploy custom applications at the edge. This allows customers to perform complex operations, such as dynamic content personalization and real-time data processing, directly on Fastly's infrastructure.
- Developer-Centric Approach: Fastly's focus on providing a developer-friendly platform has fostered a strong community of users who contribute to the platform's ecosystem and drive innovation.
- High Performance: Fastly's network is designed for speed and reliability, delivering exceptional performance for demanding applications. The company's global network of edge servers ensures low latency and high availability for its customers.
- Switching Costs: Once customers integrate Fastly's platform into their infrastructure, the switching costs can be significant. Migrating to a different provider would require substantial engineering effort and could potentially disrupt their operations.
- Reputation and Brand: Fastly has built a strong reputation for providing high-quality services and exceptional customer support. The company's brand is recognized and respected within the CDN and edge computing industry.
However, the moat is not insurmountable. Large cloud providers are increasingly offering CDN and edge computing services as part of their broader cloud platforms, which could pose a competitive threat to Fastly.
5. The Quality Scorecard (1-5 Scale)
- Network Effects: 3 - While there isn't a traditional direct network effect, a larger, more diverse customer base can improve the platform's data analysis capabilities and security posture through shared learnings.
- Recurring Revenue: 4 - Usage-based pricing creates strong recurring revenue, although subject to fluctuation based on customer activity.
- Scalability (Gross Margins): 5 - High gross margins demonstrate the scalability of the business model.
- Financial Strength (Cash vs Debt): 3 - Fastly has a moderate amount of debt, but sufficient cash reserves. Monitoring their burn rate is crucial.
- Innovation: 5 - Compute@Edge demonstrates a commitment to innovation and pushing the boundaries of edge computing.
6. Valuation & Scenarios
Fastly's current valuation is dependent on several factors, including its revenue growth rate, profitability, and market sentiment. We have considered a range of scenarios to assess the potential upside and downside for the stock.
- Base Case: We project revenue growth of 20% per year over the next five years, driven by increased adoption of edge computing and expansion into new markets. We assume that Fastly will achieve breakeven profitability within three years and generate positive free cash flow thereafter. Based on a discounted cash flow (DCF) analysis with a 10% discount rate and a 3% terminal growth rate, we arrive at a price target of $30.
- Bull Case: In this scenario, Fastly experiences rapid growth, driven by the success of Compute@Edge and strong demand for its CDN services. We project revenue growth of 30% per year over the next five years and assume that Fastly will achieve profitability within two years. The DCF analysis yields a price target of $45.
- Bear Case: This scenario assumes slower revenue growth, driven by increased competition and execution challenges. We project revenue growth of 10% per year over the next five years and assume that Fastly will struggle to achieve profitability. The DCF analysis results in a price target of $15.
Currently, Fastly trades at a Price-to-Sales ratio that reflects its growth potential, but also its current unprofitability. Future multiple expansion depends on consistent execution and demonstrating a path to profitability.
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7. Key Risks
Investing in Fastly involves several key risks:
- Competition: The CDN and edge computing market is highly competitive, with established players such as Akamai and Cloudflare, as well as large cloud providers like Amazon, Microsoft, and Google. Increased competition could put pressure on pricing and market share.
- Customer Concentration: Fastly has historically relied on a small number of large customers for a significant portion of its revenue. Loss of any of these customers could have a material impact on the company's financial results. (Note: Diversification efforts are underway, but it remains a risk).
- Technology Disruption: The technology landscape in the CDN and edge computing market is constantly evolving. New technologies or approaches could emerge that render Fastly's platform obsolete.
- Security Breaches: As a provider of security services, Fastly is a target for cyberattacks. A successful security breach could damage the company's reputation and lead to customer churn.
- Execution Risk: Fastly's growth strategy depends on its ability to successfully develop and market new products and services, expand its customer base, and scale its operations. Failure to execute on these initiatives could hinder the company's growth prospects.
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8. Conclusion
Fastly is a compelling investment opportunity in the rapidly growing edge computing market. The company's technological leadership, developer-centric approach, and high-performance platform provide a strong competitive advantage. While competition and execution risks remain, we believe that Fastly is well-positioned to capitalize on the expanding market opportunity and deliver significant returns to investors. Our Buy recommendation is based on the expectation that Fastly will successfully execute on its growth strategy and achieve sustainable profitability. Investors should carefully monitor the company's progress in diversifying its customer base, scaling its Compute@Edge platform, and improving its financial performance. The recent volatility in the share price presents a favorable entry point for long-term investors who are willing to tolerate short-term fluctuations. The future of Fastly rests on their continued innovation and ability to effectively address the growing demand for edge computing solutions.