As I work through analysis of recent earnings reports for the companies currently in my portfolio, I also like to check back on progress for companies that I had owned previously. In each case, I had a reason to own the stock, based on their product portfolio, growth potential and alignment with broader trends in software infrastructure. However, every thesis does not play out as expected and subsequent missteps in company execution can lead me to downsize or exit a position until the company appears poised for growth again.
FSLY Stock Chart, YCharts
Fastly (FSLY) is one such stock. I had owned FSLY during its COVID driven surge in 2020, enjoying price appreciation from the $20 range in May 2020 to break $100 by August. After some disappointing earnings reports later in 2020, I began reducing my position in increments around $80-$90 and closed it in early 2021. The stock continued to underperform in 2021, dropping below $10 in 2022. While software infrastructure stocks in general have lagged in 2022 due to macro effects, FSLY began its slide in 2021. Yet, peers were hitting all-time highs.
Continuing my series of looping back on a few companies that I had held previously, I thought it would be instructive to revisit Fastly (FSLY). I had owned Fastly stock during its heyday in 2020, entering in early 2020 and ramping up my position after their strong Q1 2020 results and initial guide for Q2. By May 2020, FSLY was one of my largest positions with a cost basis of $32. The stock took off over the summer, jumping from the low $20 range in May to break $100 by August.
It eventually reached a peak of $128, before pre-announcing weak Q3 results, stunning the market. Yet, FSLY still managed to break $100 again in early 2021, as investors assumed it might recapture its prior momentum. Unfortunately, it didn’t, delivering one poor quarterly report after another. Following the disappointing Q3 2020 earnings, I began reducing my allocation in the $80-$90 price range and still managed to capture a favorable upside. I finally closed my position in early 2021.
Internet usage patterns and delivery of software applications are undergoing major paradigm shifts. Decentralization is the primary pattern – transitioning away from fixed network entry points, concentrated clusters of compute and single data stores. These changes are being driven by the rapid evolution of work habits, software architectures, connected devices and data generation. After years of Internet resource convergence, we are witnessing a shift towards the broader distribution of compute, data and network connectivity.
Software applications are pushing processing workloads and state outwards towards the end user. This transition began to lower response times for impatient humans, but will become a necessity to coordinate fleets of connected devices. With work from anywhere, network onramps cannot all be routed through central VPN entry points protected by firewalls. Distributed networks backed by dynamic routing will increasingly facilitate point-to-point connections between enterprise users, their productivity apps, corporate data centers and local offices. Massive troughs of raw IoT data have to be summarized near the point of creation before being shipped to permanent stores.
These changes are being driven by exogenous factors, reflecting the same bias towards decentralization. Workers are less likely to concentrate in large office campuses where their network connectivity can be protected by closets of security hardware. The proliferation of connected devices and high-bandwidth local wireless networks are creating new opportunities to streamline industrial processes and enable machine-to-machine coordination. Privacy concerns are prompting government regulations to keep user data within geographic boundaries. The convenience and efficiency of digital engagement are forcing enterprises to move consumer touchpoints onto virtual channels.
Overlaying these trends is an increasing need for security. While hackers have existed for years, the decentralization of defenses and migration away from physical engagement are creating new opportunities to exploit vulnerabilities as technology tries to catch up with consumer habits. Information sharing, corporate-like organization and untraceable payment systems are propelling the practice of hacking into a thriving business function. This has thrust digital security from the back of the enterprise to the front office, layering over every corporate activity. Digital transformation extends the same risks to the enterprise’s customers.
These forces are creating significant opportunities for nimble software, network and security providers. Entrenched technology companies are responding, but existing business incentives and fixed system architectures are creating inertia. Foundations in centralized compute infrastructure, big data stores and network hardware sales are difficult to evolve. Newer companies grounded in a distributed mindset are better positioned architecturally, commercially and culturally to address the new landscape. Focused independent players will carve out large portions of the growing market for distributed Internet services.
In this post, I explore these trends in network connectivity, application delivery and data distribution, and then link them back to the independent, forward-thinking public companies that are capitalizing on them. While many companies are lining up against these trends, I will try to limit my focus on the implications for a few high growth software and network infrastructure companies tracked on this blog. Specifically, these include Cloudflare, Zscaler and Fastly. I will also use this narrative to weave in updates on each company’s recent quarterly results, product developments and strategic moves.
Much has been written about how enterprises are awash in data, generating new signals at an accelerating rate. A lot of this focus has been on the data analytics and machine learning space, where arguably a large opportunity lies. Businesses are struggling to process all their data in order to gain new customer insights and improve performance. Recent IPOs like Snowflake, C3.ai and Palantir have driven investor interest and delivered valuations that reflect the huge potential.
While these opportunities in big data convergence, AI and advanced analytics are exciting, an equally significant evolution is happening on the transactional side of data storage and distribution. Models for data storage have moved far beyond a single large relational database housed on premise. Application architectures are evolving rapidly, with the return of rich clients, disparate device channels, an ecosystem of APIs and breaking up monoliths into micro-services. Cloud hosting and serverless have provided new ways to manage the runtimes that execute code. Software engineering roles have been coalescing, highlighted by the ascendancy of the developer and a bias towards productivity.
These forces are creating opportunities for emerging technology providers to capture developer mindshare and power application workloads. Cloud-based services have lowered the barrier to entry for launching new transactional data storage solutions. In the same way that Snowflake created a robust offering separate from the hyperscalers, independent data storage companies are thriving on the transactional side. This blog post provides investors with some background on application data storage technologies and an examination of trends in modern software architectures. It concludes with a survey of companies (several that are publicly traded) which stand to benefit as application workloads explode.
Fastly had a dramatic quarter. After breaking $130 a share, in mid-October they pre-announced an expected miss for their Q3 revenue guidance, primarily attributable to revenue underperformance from their largest customer. This triggered a downward spiral for the stock to the $80’s prior to the actual earnings announcement on October 28th. The Q3 report largely met reduced expectations, but called into question the near term growth story as Q4 estimates appeared soft. The stock subsequently dropped into the $60 range, but has recovered since into the low $80’s as investors seem to maintain confidence in the long term story. Even with this volatility, the stock is up 286% in 2020.
Additionally, over the past several months, Fastly announced and completed the acquisition of Signal Sciences. Management highlighted the large opportunity for cross-sell to existing customers, adding rapid revenue growth and higher gross margin to the core business. They announced plans to combine product solutions for application and API security into a new offering called Secure@Edge. In mid-November, Fastly held their annual user conference, Altitude, which included a slew of product updates, customer talks and insights into next year’s roadmap.
In this blog post, I review the latest earnings report, the Signal Sciences acquisition and announcements from Altitude. I also revisit the competitive landscape and broader dynamics in the evolving edge compute, software-defined network and security markets. This information should help investors evaluate their own consideration for an investment in FSLY stock. At the end, I discuss application to my personal portfolio and investment plan going forward.
On August 27, Fastly announced their intent to acquire Signal Sciences. An outcome of the acquisition will be to combine the security capabilities of both companies into a new product offering called Secure@Edge. This significantly bolsters Fastly’s existing security product line, providing an accretive blending of existing offerings with new ones provided by Signal Sciences into a comprehensive solution designed to protect modern web applications and APIs at scale. I don’t normally dedicate a blog post to every acquisition, but I think this one will deliver an oversized contribution to the trajectory for Fastly and provides more justification for bullishness going into 2021. In this post, I will dig into Signal Sciences, synergies with Fastly and how the combined company is positioned for rapid growth. Interested investors can review my prior coverage of Fastly for more detail on the investment thesis.
Fastly (FSLY) reported Q2 earnings on August 5, 2020. On the surface, the performance was impressive, beating estimates on both the top and bottom line and raising Q3 and full year guidance. While Q2 revenue accelerated 24% sequentially over Q1, the market was looking for greater outperformance. This was evidenced by the stock’s nearly 18% drop the following day. After the 5x run-up in FSLY stock since the beginning of 2020, there was likely some profit taking as well. As part of the earnings release, Fastly management provided updates on the Compute@Edge beta and discussed a number of customer wins. In this post, I review Fastly’s Q2 earnings and other business updates that occurred during the quarter. I also dig into their evolving product offerings and revisit the competitive landscape. For a refresher on my prior coverage of Fastly, please see my original analysis, Compute@Edge deep dive and past quarterly updates.
Cloudflare (NET) kicked off Serverless Week with a blog post from their CEO on Sunday, July 26. The event ran this past week and highlighted a number of enhancements to Cloudflare’s serverless edge compute product. These included reduced cold start times, additional language support, improved developer tooling and lower price points. They also unveiled a new offering called Workers Unbound, which removes prior restrictions on CPU usage to allow for long running processes. These are all very exciting for serverless edge compute adoption and represent a step up in capabilities for Cloudflare. In this post, I will dig into the changes announced and what these imply for usage of Cloudflare’s Workers product. I will also try to draw parallels to Fastly’s Compute@Edge offering, based on what we can glean thus far (still in beta). At a high level, this progress from Cloudflare provides further momentum for the migration of application processing out of central data centers (whether cloud or private) to the network edge. This trend should benefit both FSLY and NET, as leading independent providers of serverless edge compute solutions.
Early in the evolution of cloud computing infrastructure, the cloud providers were rapidly expanding their offerings. For a while, it seemed they would leave no room for independent providers in a land grab to address every segment of software infrastructure. As the landscape has matured and enterprises increasingly implement a multi-cloud strategy, it has become clear that independent providers can not only co-exist, but thrive, in this environment. Examples are Datadog for observability, Twilio for communications, MongoDB for databases and Fastly for CDN.
This blog post examines the history of cloud service providers and the evolution of their offerings. As cloud vendors have defined broad categories of software services, they have left openings for nimble, focused independent software vendors to leverage the same cloud infrastructure to deliver substantially better product offerings in some segments. From this, we can draw observations about why they are succeeding and what they need to continue doing. Investors occasionally raise competitive concerns for independent software providers that cloud vendors will choose at some point to crush them. I posit that threat has passed in many categories. This post seeks to help investors understand what has changed and how to reason about the risks going forward for their favorite independent software company investments.
Fastly (FSLY) has experienced an incredible run over the past several weeks. The share price has more than doubled since releasing Q1 earnings on May 6. This can be primarily attributed to the major increase in guidance for Q2 and the rest of the year. There have been other surprises as well, like the observation that Amazon.com has been using Fastly POPs for content delivery. A lot of investor excitement is also pinned on the upcoming release of Compute@Edge, which represents a significant extension of Fastly’s current CDN offerings. Since the product is in beta, it isn’t clear how sizable the revenue impact will be. Given this, I thought it would be worth spending some time examining how Fastly has approached building new technologies in the past and what this might mean for their future edge compute offering. I also wanted to share my understanding of the technical underpinnings of the platform and how these differ from other serverless offerings currently on the market. Whether Fastly’s surge represents a one-time COVID-19 driven bump or they will sustain long-term usage growth remains to be seen. With this information, investors can decide for themselves if the Fastly story is hype or their edge compute platform represents the beginning of something fundamentally disruptive.
