Fastly's air pocket slump

Fastly is the leader in edge compute, driving the massively valuable shift of compute processing to edge servers. The stock is down over 20% today after announcing tepid Q2 sales guidance (below our & analysts' estimates) and the news that it will be transitioning to a new CFO.

Below is our analysis of what went wrong with this Q1 earnings release, what management's forward guidance may imply, and how we're thinking about the stock.

Q1 Recap

First, a quick reminder on what Fastly does:

• The company operates an edge cloud platform for processing, serving, and securing its customers' applications.
• The "edge" is the point in the network just before you lose control of the data.
• Their edge cloud platform moves data and applications closer to users, at the network edge — so that they can meet rising customer expectations, deliver secure, competitive online experiences, and bring innovative ideas to life, faster.
• The mission-critical nature of Fastly's services is evident in its major customer base, which includes Shopify, Microsoft, Hulu, Slack, Reddit, The New York Times, and many others.

Overall, Q1 results were generally solid:

• Revenue of $85M was in line with management's $83-86M guidance and above analysts' $84.3M estimate, with 24% organic growth (excluding contribution from Signal Sciences acquisition). Not terrible considering the +38% organic growth it saw in the year-ago period (a tough comparison).
• New customer additions were +123 (strongest we've seen from FSLY, with major land & expand opportunities), reaching 293 total. This adds some credibility to management's steep implied 2nd half 2021 revenue growth acceleration (explained below).
• Gross margins marched higher to over 60%, with EBITDA better than analysts' estimates too.
• Contributions from the Signal Sciences acquisition and Fastly's Compute@Edge platform are heading in the right direction (SS customers and revenues grew 5%/15% vs. 4Q20 and should provide large cross-sell opportunity; C@E will support Javascript which should the universe of potential customers for Fastly over time). However, neither of these efforts are really impacting Fastly's financials in a positive way yet.

Management Guidance + CFO Transition

Unlike the Q1 results, Fastly's Q2 guidance and its implications for the remainder of 2021 were mixed to negative.

• Management guided to Q2 revenue of $84-87M (vs. analysts' $92M estimate), implying only mid-teens growth including Signal Sciences. Definitely lower than our and Wall Street's expectations, despite the tough +62% comparison from 2Q20. Headwinds from large customer TikTok are a major contributor here.
• The CFO is stepping down once the company finds a replacement. This was a surprise to us, even though some investors have been lukewarm on the CFO in recent years given his mismanagement of Wall Street's expectations.

On the plus side, management did raise its full year 2021 revenue guidance to $380-390M, implying a major acceleration into the 2nd half of the year (38-42% growth). Their reasons for this guidance included land and expand opportunities, cross-selling and better sales execution.

The company is suffering from an "air pocket" of tough 2Q20 comparisons while the Signal Sciences acquisition and important product efforts (Compute@Edge) have not yet kicked in. The weak 2Q21 guidance and the CFO resignation news were the nails in the coffin for the stock today.

It's clear that many investors are not buying that full-year guidance (and the 2nd half ramp it implies) and need to see a quarter or two of improving execution before trusting guidance again.

What To Do With The Stock

In some ways, these quarterly results and FSLY's sharp sell-off reminds us of our experience with Twilio in 2nd half 2019.

• The market had been undergoing a short-term rotation out of growth and momentum stocks in late 2019.
• After its Q3 earnings release, Twilio's stock fell over 10% despite solid Q3 results due to a slight cut in Q4 sales growth estimates after a Q3 billing issue which caused investors to question management's execution ability.
• The combination of tepid guidance and management execution stumbles during a tough market rotation led to the TWLO sell-off.

At the time, we published an update explaining our napkin math on the long-term Twilio opportunity. To summarize our thinking: "Bears are assuming Q4 sales guidance is representative of the next 3+ years for Twilio. We disagree." We stuck to our thesis and held onto the position for our Flagship strategy despite the short-term volatility. The stock is up 200%+ since then.

The jury is obviously still out on whether FSLY will end up looking like TWLO (i.e. this Q1 release being a one-off execution failure in an otherwise strong secular growth story), or if the fundamentals are breaking down (with an optically high EV/Sales valuation multiple to boot). The stock is now a "show me" story: we need to see improving progress in the coming months to reassure ourselves that our long-term thesis is tracking.

At the current valuation, we believe FSLY is quite attractive -- if you believe management's guidance. That's a big if, to be sure, and the reason the stock is down so much today.

We do continue to believe in our original 5-year thesis for the company and are tempted to buy more of the stock here, but we need clearer signposts first.

For now, we are holding onto the stock and not selling based on one quarter's results alone. Our thesis has always been a long-term one to be measured in years, not quarters.