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Analysts Love Fastly Stock Despite Its Broken IPO

Rich Smith, The Motley Fool

Every day, Wall Street analysts upgrade some stocks, downgrade others, and "initiate coverage" on a few more. But do these analysts even know what they're talking about? Today, we're taking one high-profile Wall Street pick and putting it under the microscope...

Three weeks and two trading days ago, cloud computing company Fastly (NYSE: FSLY) went public.

Shares began tanking almost immediately, eventually hitting a low point 23.5% below their IPO price.

But three weeks later, the quiet period binding Fastly's underwriters to silence expired -- and Wall Street leapt into action.

Yesterday -- the first day they were permitted to do so -- Fastly's underwriters gathered en masse to issue endorsements of the stock. At last report, no fewer than seven separate Wall Street firms had issued buy ratings (or the equivalent).

Here's what you need to know.

Five dice labeled buy and sell on top of an LCD screen displaying stock charts and numbers

Image source: Getty Images.

Introducing Fastly

Let's begin with a short introduction to Fastly. Described alternately as an "edge cloud software company" and an "infrastructure-as-a-service (IaaS) platform," Fastly offers to shave "milliseconds" off the response times of corporate websites responding to end user requests. It does this by caching data on the "edge" of the "cloud" -- basically distributing copies of data in servers closer to end users, so that when data is traveling around the internet, it has a shorter round trip to make.

As the company explains, this helps "websites and apps perform faster, safer, and at global scale."

It's a popular idea that helped drive 38% revenue growth for Fastly last year. From an investor's perspective, however, the company's business has so far remained mired in unprofitability, losing about $30 million and change in each of the last two years (and burning more than $40 million in cash over the last 12 months, according to S&P Global Market Intelligence).

Wall Street weighs in

Nevertheless, Wall Street likes the growth rate, and predicts that by 2023, Fastly's revenue will be four times what it made in 2018 -- about $608 million. Street estimates show that even at that level of sales, the company will still be unprofitable. Regardless, yesterday morning seven of Fastly's 10 underwriters -- Merrill Lynch, Credit Suisse, William Blair, RW Baird, Oppenheimer, Stifel Nicolaus, and D.A. Davidson -- all took advantage of the quiet period's expiry to rush out buy ratings on Fastly stock.

Why are these bankers so eager to recommend a profitless company, with little prospect for earning a profit any time in the near future? Here's a sampling of their comments, courtesy of our friends at TheFly.com and StreetInsider.com (subscription required):

  • Fastly's software-based edge computing platform is "superior" to existing methods of content delivery over the internet, and is attracting "strong" levels of new customer additions. Continued annual sales growth of "at least" 30% is likely, and "[p]rofitability should also improve" as the company "gains scale." (Stifel Nicolaus)
  • "[T]rends such as digital transformation, 5G mobile networks, analytics, and arti[f]icial intelligence/machine learning (AI/ML) are driving the evolution of websites that require more agility, scalability, and [f]lexibility than traditional CDNs are able to provide." In meeting these needs, "Fastly is disrupting the traditional CDN (content delivery network) market." (William Blair)
  • And the market Fastly is targeting could eventually be worth $18 billion, according to Oppenheimer. The analysts says the company is "well positioned as the cloud moves to the Fog, driving enterprise digitization over the next decade."

And yet, despite all this, the stock is selling below its IPO price. Why is this? Credit Suisse deadpans that the demand for Fastly's "Edge Clouds" is "underappreciated."

Even some underwriters underappreciate Fastly

Perhaps worryingly, some of this underappreciation may even extend to Fastly's own underwriters. In contrast to the seven analysts who initiated Fastly with buy ratings yesterday, two of the company's own underwriters took a more cautious stance, with Citigroup and Raymond James rating it neutral and market perform, respectively.

Why? We don't have a lot of detail about RJ's rating, but Citi set a neutral rating (and a $23 price target) on shares, warning that Fastly's edge cloud business model is primarily a "share-gaining CDN business today" -- meaning that while it may take away revenue currently enjoyed by traditional content delivery companies, it's not necessarily growing the market for content delivery much. Moreover, Citi notes that Fastly's lack of free cash flow makes the stock's valuation "challenging," and the company's "generally lower margins" than its peers is another reason to be leery.

What it means to investors

Such cautious language -- and coming from the second-largest underwriter of Fastly shares just three weeks ago -- isn't going to do much to shore up investor confidence in this broken IPO.

Indeed, after briefly ticking up in response to all the buy ratings yesterday, Fastly stock is down again today -- off more than 5% in midday trading. With a market capitalization of $2.1 billion, but only $158 million in trailing revenue (so a price-to-sales ratio of 13), no profits, and no free cash flow to support its business, I cannot say I blame investors for being cautious on this one.

When it comes to Fastly, even just one neutral rating from this one underwriter may hold more weight than seven buy ratings from the others.

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Rich Smith has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.