Is Fastly (FSLY) A Buy After 90% Drop?

Fastly, ticker FSLY, was one of the hot stocks during the COVID-19 pandemic. The company went public in 2019 and started its first trading day at around $21 per share. By October 2020, its stock was trading at nearly $130 per share, up by more than 400% in roughly a year and half after its IPO. Two years after, by the end of 2022, the stock lost almost all of its value, trading at $7 per share. The rise and fall of Fastly is a classic example of a pandemic stock. Is the post-pandemic price slump an opportunity to buy shares?
Let's talk about that!

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I'm Hoda Mehr, founder, and CEO of Stock Card, and on this blog and its accompanying YouTube channel and Podcast show, I share detailed fundamental analyses and interesting investment stories.

This post is part of a series I started last week to research companies I own that are down significantly from their all-time highs to decide whether to buy more or sell and allocate money to other companies. Last week I researched Canopy Growth (CGC), the link in the show notes, and I'll continue with this series for a few more weeks.

​Remember, these videos are for education and sharing ideas and not advice to buy or sell any securities.

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The Two Categories of Pandemic Stocks

The COVID-19 pandemic created several interesting examples of rapidly growing stocks to unbelievable all-time highs and subsequent crashes to unimaginable all-time lows. Fastly is one of those stocks. We all know that the pandemic drastically increased the demand for content online. Accordingly to Fastly's blog, during the pandemic, some countries, such as Italy, experienced more than a 100% increase in online traffic resulting in a drastic decline in internet speed. Fastly was there to speed up the internet's speed. As the pandemic subsided and the demand for online content went back to its normal rate, Fastly's stock price followed suit.

This part of the story is quite common across the so-called pandemic stocks. However, they are split into two categories:

1. Fundamentally strong companies that we can now invest in at a great price,
   
2. Those that are struggling fundamentally, and the price drop is justified.
   

In the next few minutes, we will research Fastly together and decide which of those two camps it belongs to.

Fastly (FSLY) Fundamental Analysis

As always, we start any company's fundamental analysis by understanding what the company does. In lament terms, Fastly makes the internet faster. When you buy a ticket from Ticketmaster for the next event you plan to attend or are loading an article on the New York Times website, Fastly is working behind the scenes to load that page for you oh so Fastly. Fastly's technology is called CDN or Content Delivery Network. Its market is expected to grow by 18.31% per year between 2022 and 2032.

If you want to see Fastly's competitors in the CDN market, type content delivery network or CDN in the search bar on StockCard.io and get the full list of CDN companies, or click here to get the list.

Back to Fastly, the company is growing its revenue by double digits. Its gross margin is hovering close to 50%. It has a solid balance sheet with over $600M in cash and cash equivalent and an acceptable 0.7 times debt-to-equity ratio.
If things are acceptable and reasonable, why is the stock price down significantly since its 2019 initial public offering?

• The company isn't generating profit or free cash flow, and even with the price drop, the stock is still trading at almost five times its sales.
  
• It underwent a CEO change in mid-2022, which investors never like to see. Now the investors expect profit and free cash flow.
  
• In the latest quarterly earnings call, analysts were all about cost reductions. They wanted the management team to explain how Fastly plans to reach positive earnings before tax, depreciation, and amortization, or EBITDA.
  

In response, the company's CFO discussed how in their last quarter in 2022, they managed to achieve almost a break-even point in adjusted EBITDA. The CEO and his team also talked about negotiating their contracts with their suppliers, cutting down on investing in unnecessary hardware and managing Fastly's workforce to achieve profitability. Those are all reasonable plans. They are just not convincing yet. The management promised more concrete details in the upcoming June investor day presentation. But for now, we only have a few directional plans toward profitability.

Is Fastly (FSLY) A Buy Now?

Knowing all the above analysis, what do we do with Fastly? Buy the post-pandemic dip, or stay away?
An optimal long-term investment thesis for any company is strong fundamentals with low market expectations. The more I grow into my career as an investor, the more inclined I'm to find investment opportunities that meet those two criteria.
Fastly, unfortunately, doesn't meet either of those criteria. It's growing at the same pace as the market, in the 20% range. And Investors are already pricing the stock five times its sales, and the path to profitability is still unclear. Those tell me the company isn't yet fundamentally solid, and the market's expectation is already baking in a five-time growth in revenue.

Fastly's Rule 200 Analysis

There is one more analysis I'd like to run on Fastly. It's known as Rule 200.

It's a quick formula the venture capitalists use to measure a growth company's financial strength, and I'd like to use it to measure the strength of tech stocks I invest in. For Rule 200 to give a company a thumbs up, the sum of its revenue growth, gross margin, operating margin, and net revenue retention has to be higher than 200.

Fastly's revenue grew 22.12% last year. Its gross margin is 48.48%.The operating margin is - 56.90%, and its net revenue retention is 119%. Sum that all up, and we get 132, significantly lower than 200.

The negative operating margin would have been fine if Fastly had been able to grow much faster or had a significantly higher gross margin. But as it stands today, the company doesn't meet the Rule 200 criteria either. No wonder high-growth technology investors such as Cathie Wood sold all her fund’s investment in Fastly in mid-2021. 

Analysts' Target For Fastly (FSLY)

​It's important to note that earlier in the year, in mid-Feb, several analysts, including Bank of America analysts covering Fastly) upgraded their Fastly recommendations from sell or hold to Buy with price targets around $16 to $26 per share, sighting gross margin improvement and cost reductions. In April 2023, as I'm doing this research, we are already there at roughly that target price. So sadly, if you invested in the company at its IPO or when it was priced at $50 or $100 and held on to them like me, we may have to wait a long time to recover to those levels, if ever.

Bottom-line on Fastly's Stock

You can wait until June's investor day by the company. That's when the management is supposed to share more concrete plans for reaching profitability. However, fundamentally, unless we see another significant surge in internet content delivery needs like what we experienced during the pandemic, there is no reason to expect Fastly to return to the previous all-time highs of the pandemic era anytime soon.

Now, it's your turn to share your thoughts on Fastly. Do you see fundamental reasons to buy now or hold the stock longer?  You can go to Stock Card and look up Fastly's Stock Card to start your research. Click here to jump to it's Stock Card.

Next week, I’ll be back with a fundamental analysis of Snap (ticker SNAP) as a part of my beaten-down research series. I'll see you next time.

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