With Fastly’s share price up +30% last week, there has been a lot of speculation about what has been driving the rally. Perhaps it was an updated press release of its partnership with Google Cloud, or the TikTok deal is finally reaching its conclusion behind the scenes, or the rumours of updated guidance. It seems unlikely to me to be any one of the three in isolation. Irrespective of what has been driving the share price, Fastly seems to be in a good position to beat its Q3 guidance (and beyond). Here’s why.
The Base and Guidance
First, let’s have a look at Fastly’s revenue growth:
**$m QoQ% YoY %** Q119 45.6 +12% +40% Q219 46.1 +1% +34% Q319 49.8 +8% +35% Q419 59.0 +18% (!!) +44% Q120 62.9 +7% +38% Q220 74.7 +19% (!!) +62% **Q320 74.5 +0% +50%** **(guidance)**
Immediately what jumps out at you is that after six consecutive quarters of sequential growth since IPO, Fastly have guided FLAT.
So why is that? From their Q2 earnings call:
Analyst: "I wonder if you could just talk about more broadly the factors that are informing Q3 guidance. I mean when I look historically, normally you have a pretty good pick up sequentially from Q2 to Q3. And guidance assumes something that’s flatter to maybe down slightly at the midpoint. And so just trying to figure out how much of that’s conservatism versus maybe any change in trend?"
Adriel Lares – Chief Financial Officer
"So in general, we do see — we begin to see some pickup from sort of Q2 to Q3. I think the thing to keep in mind, clearly, is Q2 this year relative to previous years. Seasonally, Q2 versus Q1 is actually relatively flat.
Clearly, that’s not what we experienced this year. So I think you have a bit of a comparison challenge when you think about Q2 to Q3. So the fact that we’re still at the midpoint here, getting some pretty strong year over year growth rates, I think, is worth noting. So from our standpoint, we have built in last quarter the idea that folks would be coming — getting back to sort of a normal life from a shelter-in-place to be able from before.
And we’re beginning to see that sort of as a mixed bag. It’s mostly coming true. But that’s — what’s a little bit uncertain here is kind of how the rest of the world, in some respects, the rest of the United States is going to sort of play that out. So in some respects, the sort of the normal seasonality is sort of being sort of thought up in sort of Q4.
But with respect to Q3, it’s somewhat respective, ameliorated a bit by the comparison to sort of a very, very strong Q2.
So from that standpoint, I think that, that’s probably the biggest thing. And then there is just uncertainty, as you know, just with respect to one of our largest customers as well as with respect to school closures, how those will be deployed. And in some respects, how they will be adhered to regionally. Q2 was unique in the sense that effectively, the entire world was sort of working in lockstep with respect to shelter-in-place orders and school closures.
And I think as we move beyond that period into Q3 and into Q4, it’s a bit uncertain. I don’t know even how that’s all going to play out, so you probably see a little bit of conservatism there as well."
There are two key factors at play here: 1. A stronger than normal Q2 performance leading to a higher base & comparative and 2. Seasonality. We have one benefit from when Fastly management laid out their guidance in early August: hindsight. Let us consider that Fastly’s Q3 is the three months from July 1st to 30 September. Q1 was from April 1st to June 30th. Do we think that seasonality will be as much as a factor in the last few months as traditionally, can you differentiate much change in the Covid environment between June and August for example? In my opinion, what was a usage driver for the business in June will continue to have been a driver in September.
Don’t forget that Fastly is also somewhat diversified from a ‘reopening’ of the macro-environment, as Peter Offringa explained in his Q2 recap (https://softwarestackinvesting.com/fastly-fsly-q2-recap/):
"However, management noted on the earnings call that some customers in impacted verticals, like travel and hospitality, actually dropped below the $100k spending threshold in the quarter. They didn’t provide detailed counts for customers moving up versus moving down. Fastly has many long-time customers in travel and hospitality, like Kayak, Airbnb, TripAdvisor, Ticketmaster and Hotel Tonight. These companies have reported significant reductions in usage year/year, over 80% in some cases. It is understandable that they would be impacted. https://softwarestackinvesting.com/fastly-fsly-q2-recap/&quo….
I could also envisage some upside here in Q3 to offset the assumed seasonality, as airlines and travel companies have had to rapidly scale their ‘social distancing’ measures to continue any form of operations.
So where does this fall in our equation for revenue growth: (Existing customers - churn) x DBNER + new customers.
It falls within DBNER. Fastly’s Q2 +62% YoY revenue growth was largely driven by increased spending of it’s Enterprise customers (DNBER of 137% up from 133% in Q1 20, average Enterprise customer spend of $716,000 versus Q1 $642,000), which is in turn driven by usage. It’s important to note that an uptick in usage does not necessarily correlate 1:1 revenue, a correlation that many (myself included) may have overstated ahead of Q2 after Shopify, Pinterest, TikTok, Etsy and many others of Fastly’s customers had reported explosions of traffic above expectations.
You’ll also note that in Q419 revenue jumped +18% sequentially, more or less what it has just done with the pandemic tailwinds in Q2. Fastly have modelled the same trend again into it’s FY20 guidance, with Q4 revenue guided to be +18% sequentially again. I would speculate a significant driver of this Q4 outperformance is due to the seasonality of its e-commerce customers (Shopify, Etsy etc). The November-December period, encompassing Black Friday and Christmas shopping, is the peak time of year for retailers and by some distance, with over $1 trillion spent annually over the holiday season. But historically 50% of people still shop in store. I suspect with the advent of online shopping being supercharged to new highs this year and with a sect of new customers, that this Q4 will see the mother of all ‘Black Fridays’ and holiday sales online. This should only benefit Fastly (and its e-commerce customers) and I’d expect upside to the traditional +18% Q3-Q4 sequential growth.
The TikTok drama has yet to be resolved. However, what we do know is 1. that it hasn’t been banned yet and 2. it was baked into Fastly’s guidance. We have had multiple threads on Fastly & TikTok, so without going into much detail, if we assume 6% revenue impact from TikTok US that Fastly had factored into their FY guidance, that would be around a $4.5m uplift to Fastly in Q3 (raising their guidance from 50% YoY to 59%). If we are prudent and assume only a third of that was baked in to Q3 (due to initial ban deadline being on September 15th), that still brings their revised Q3 guidance up to +53%. It’s worth bearing in mind that ahead of the proposed ban TikTok downloads spiked considerably, and TikTok was the most downloaded app in the world in August 2020. As Fastly’s largest customer at 12% of revenue in Q2, I would not be surprised to see that proportion increase in Q3, an unexpected boon for its usage.
Perhaps the most obvious indicator that Fastly will beat their Q3 guidance is the acquisition of Signal Sciences. The long term synergies and cross-sell opportunities of the deal is clear, but in terms of Q3 the acquisition is immediately accretive to revenue. This means +$28m of Annual Recurring Revenue (growing 62-100% YoY) will be incremental to its FY guidance, a quarter of which added to the TikTok impact above, might bring Fastly’s updated Q3 guidance to +56-60% YoY conservatively (on a like for like basis - eg with Signal Sciences prior year included), or +66-70% YoY on an incremental basis.
What had concerned me most about Q2 earnings was a slowing in the number of Fastly’s Enterprise customers (>$100k annual spend), which account for 88% of Fastly’s revenue. However, Signal Sciences brings with it 42 new Enterprise customers to add to Fastly’s 304. For a company that only reported +7 new Enterprise customers in Q2, this is a significant tailwind going into the next 12 months.
All in all, while I think it’s safe to say that Fastly will beat its Q3 guidance, I see a bigger upside in raising its FY guidance and going into 2021. Growing at somewhere between 62%-100% Signal Sciences could bring in up to $35m incremental revenue this year, and upwards of $50-60m in 2021 - and this isn’t taking into account the cross-sell opportunities. We will have to wait for a resolution to TikTok, but assumedly around $5-7m risk has been baked in to Fastly’s full year guidance. Modelling in TikTok and Signal Sciences in to Q4, I think raised FY guidance could see Fastly achieving revenue between $330-345m in fiscal 2020 which equates to +65-73% YoY incrementally or +53-60% YoY on a like for like basis, up from previous guidance of +50%.
I could of course be under/over shooting it, or misinterpreting the accounting treatment of Signal Sciences, but regardless I think it’s clear that Fastly has multi-pronged tailwinds going into the next few quarters, and perhaps it’s this that has driven the share price to new highs.