fastly-takes-a-break-from-its-impressive-run

Fastly Takes a Break From Its Impressive Run

Fastly (NYSE: FSLY) has cooled off a bit. After an absolutely breathtaking run this spring, FSLY stock has stabilized in recent weeks. For traders new to the company, it may seem like Fastly has lost its momentum.

A magnifying glass zooms in on the Fastly (FSLY) website.

A magnifying glass zooms in on the Fastly (FSLY) website.

Source: Pavel Kapysh / Shutterstock.com

However, don’t forget about how incredible the company’s run has been in 2020. As of this writing, shares are up 347% year-to-date, even after the recent sell-off. Fastly is having good types of problems – namely that it set expectations extremely high and is struggling to keep up with the frenetic pace it set in the first half of 2020.

Still, this a hyper-growth stock trading at a sky-high valuation, so even small signs of weakness can cause sizable corrections. And with Fastly, we now have two significant points of concern. The first is that Fastly’s single largest customer is TikTok. Needless to say, that relationship is now fraught with risk. Secondly, FSLY stock is extremely expensive given its growth rate.

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Will the ByteDance Business Keep Ticking?

Earlier this month, President Donald Trump issued an executive order forbidding American companies from doing business with ByteDance’s social media network TikTok. If the order stands, TikTok will have to cease American operations by the end of September, and it will have a limited time to sell the business to a non-Chinese owner.

So far, reportedly Microsoft (NASDAQ: MSFT) and Oracle (NASDAQ: ORCL) are among the potential companies that may choose to buy TikTok from ByteDance. In the meantime, TikTok is filing a lawsuit to try to block the order. TikTok’s chief executive officer (CEO) also just stepped down. Needless to say, it’s a volatile situation at this point.

In any case, this is a major potential pitfall for Fastly. TikTok makes up 12% of Fastly’s revenues at the moment. Additionally, TikTok is Fastly’s single largest customer. Losing 12% of revenues would be bad enough, if that should come to pass. Even worse, it would kill a large chunk of the growth thesis, as TikTok’s bandwidth usage has exploded this year.

Remember, folks plowed into FSLY stock on the idea that the novel coronavirus is accelerating the switch to digital hobbies and diversions. TikTok was, in that way, absolutely the perfect app for people bored and stuck at home. Fastly was able to use its logistical strengths to deliver a great product to TikTok and help it scale this spring. Now, however, that’s all hanging in the balance.

Plenty of Other Great Clients

While it’s a distinct possibility that Fastly will lose the TikTok account, that’s hardly the only growth avenue. Fastly’s stock has soared in tandem with that of Shopify (NYSE: SHOP), one of its key clients. Other well-known brands on Fastly include Spotify (NYSE: SPOT), Slack Technologies (NYSE: WORK) and Microsoft’s GitHub.

Thus, there is plenty of life for Fastly beyond TikTok. And while losing the stay-at-home tailwind will certainly hit the growth rate, the longer-term trajectory around rising bandwidth usage and infrastructure needs isn’t going anywhere.

Fastly has a well-liked product in a big growth market. That’s a healthy situation for long-term investors.

Fastly Is Richly Priced

FSLY stock is selling for a stunning 40 times trailing revenues and more than 25 times forward sales. These are simply mind-blowing figures. Even recently, more than 20 times sales was considered too expensive in nearly all cases.

Maybe you could justify this sort of otherworldly valuation if Fastly was putting up triple-digit revenue growth. But revenue is growing at just 62% now and set for a sharp slowdown going forward. To be clear, I’m not knocking 62% growth – that’s obviously excellent business performance. But when you see a stock at 40 times sales, usually they’re well into triple-digit revenue growth, rather than down here.

Particularly with TikTok potentially leaving and the tailwind from the pandemic fading, it’s hard to see what traders are expecting here.

It’s also worth noting that Fastly’s gross margins are significantly lower than most software stock peers. Some of Fastly’s services are something of a commodity, and thus won’t bring in the same level of monopoly profits as you’d get from more exclusive technology. These factors point to a significantly lower price-sales ratio going forward.

The Verdict on FSLY Stock

A month ago, I warned that traders should slow down in regards to Fastly. The stock’s ramp this spring was simply too much, too soon. And sure enough, since then, shares have since leveled off in the $80 to $90 range. That’s probably about right given what we know now.

It remains a red-hot market for software-as-a-service stocks. And Fastly continues to have powerful secular tailwinds, even as the specific work-from-home catalyst starts to fade.

Still, particularly with the uncertainty around TikTok, it seems that Fastly may have topped out for the intermediate future.

At the time of this writing, Ian Bezek held SPOT stock.

Ian Bezek has written more than 1,000 articles for InvestorPlace.com and Seeking Alpha. He also worked as a Junior Analyst for Kerrisdale Capital, a $300 million New York City-based hedge fund. You can reach him on Twitter at @irbezek. 

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