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An Alternative History Of Yesterday (Cestrian Stocks Bulletin #48)

Cestrian Stocks Bulletin
An Alternative History Of Yesterday (Cestrian Stocks Bulletin #48)
By Cestrian Capital Research, Inc • Issue #48 • View online
Fastly? The numbers were bad, the call was worse. Here’s what they could have said on the call, but didn’t.

DISCLAIMER: This note is intended for US recipients only and in particular is not directed at, nor intended to be relied upon by any UK recipients. Any information or analysis in this note is not an offer to sell or the solicitation of an offer to buy any securities. Nothing in this note is intended to be investment advice and nor should it be relied upon to make investment decisions. Cestrian Capital Research, Inc., its employees, agents, or affiliates, including the author of this note, or related persons, may have a position in any stocks, security, or financial instrument referenced in this note. Any opinions, analyses, or probabilities expressed in this note are those of the author as of the note’s date of publication and are subject to change without notice. Companies referenced in this note or their employees or affiliates may be customers of Cestrian Capital Research, Inc. Cestrian Capital Research, Inc. values both its independence and transparency and does not believe that this presents a material potential conflict of interest or impacts the content of its research or publications.
How Not To Be Topp
Fastly ($FSLY), the FinTwit Favorite turned Populist Punching Bag, reported its Q2 after the close yesterday. The numbers were awful. Revenue was flat on Q1 - a cardinal sin in and of itself since the business has a usage-based revenue model and, last time we looked, internet usage wasn’t flat on five minutes ago never mind last quarter - and grew just 14% on Q2 last year, a drop from the 35% growth achieved in Q1 ‘21 vs. Q1 '20. EBITDA continued to worsen, with TTM margins now at negative 16%, and cashflow got even uglier than that.
Companies have bad quarters. Happens all the time. This one was particularly bad but, again, in the life of a public company, these things are going to happen. The earnings call however was a curio. It was like the company positively wanted to keep digging into the basement of its own making. Perhaps they all wanted to get into the basement and close the hatch and pretend they weren’t there and it would all go away.
You see, what you do in such circumstances isn’t so difficult. You do this:
One, up top, in public, you atone for your sins right out the gate. This happened, that happened, it was most certainly our fault, we suck, that said we weren’t helped by External Event Bogeys #1 -4, but, it was our fault, and the buck stops with our Vice Presidents and the CFO. Er, sorry, no, with me the CEO. That’s right. The buck stops with me. Then, you keep analysts and investors focused on the long term. You paint a picture of a bright future and you lay the path as to how you are going to get them there. And you take the opportunity to throw everything and everyone bad under the bus. Any writedown you can think of, any questionable receivables, the VP Sales, not-quite-tickety-boo asset valuations, anything, you throw it all on the bonfire of your stock-based-compensated-vanity. The building’s on fire anyway, so you might as well burn it all down, thus to begin again tomorrow in a Phoenix-like fashion.
Two, below the waterline, you drop the pretense, retreat to the office and you sit down, quietly but steely, with your top team, the ones you haven’t fired yet, and you say, this is never going to happen again. Ever. Like, ever. Because, you say, we all look like idiots. And you lot - you might be idiots. But I, you say, wonderful me, I am not an idiot and you will not make me look an idiot again. (You don’t actually say these words. You say it like, we, and team, and things like that. But everyone knows what you really mean). And then, you get to work. You chop wood. You paddle furiously below the waterline to shore up half-committed customers, you run through the sales pipeline and do whatever you need to do to bring in new business, and then you run through every single line item of costs, everything, and you cut absolutely everything you can think of and then another 10% on top of that. And you know you could have cut more but by now you are exhausted and you just need a break but you can’t have one so a couple beers in the office will have to do it and righto yes it may be 2am but now let’s get back to work because, oh did I mention, we are not going to look like idiots on the Q3 call, we are going to look like heroes who were unexpectedly hit by something that could not have been foreseen in Q2 but now we have righted the ship and recovered and it is OFF TO THE RACES ladies and gentlemen and oh by the way you know all those stock awards we issued after the stock cratered well they are already GOLDEN my friends. Now, 3am, go home, see you all back here at 7am and if it’s 7.30am and you’re still not here, don’t bother coming in again. Ever.
That is what you do when you are in the place that Fastly is in right now.
The Fastly team might be doing this, but we doubt it. If anyone from the Fastly board of directors is reading this? That’s what your management team should be doing. And if they aren’t? Then get a new management team who will. Because there is a rags-to-riches story right on the plate here. And Cisco will give you the riches if you can fix or replace the rags.
Now, while we’re at it, here’s how they should have presented the numbers on the call.
They should have said: as everyone knows, we had a one-time acceleration in growth in Q2 2020. We run a usage-based model which is very fair to our customers, it means they can scale up and down with us. And that usage went off the chart early in the Covid crisis, so, Q2 2020, that was a one-time thing. We’ve been saying this all year. [Note - they haven’t. But they should have been].
Our reported growth numbers look a little disappointing in that light. We grew only 14% this quarter vs. Q2 2020. But again, that’s because we grew almost twice as fast in Q2 2020 as we expected to. If growth in Q2 2020 had been at the same rate we grew in Q2 2019 - 34% - then Q2 2021 would have shown growth of 37%, meaning we would have accelerated growth vs. Q1 2021 which was a 35% grower. So you see, our underlying growth accelerated this quarter. And that’s AFTER we wrote off $1m of deferred revenue from the Signal Sciences acquisition and it’s AFTER we lost a Top 10 customer, that customer we already told you about right at the start of this call, who has decided they are going to try to live without Fastly. We’ll see how they get on with that. So, as you can see, this quarter? It looks bad, sure. We know that. But if you look closely at the numbers, we think you’ll be as excited about the future as we are. Oh - and by the way - we haven’t been a public company for very long so you aren’t used to seeing the seasonality in our business, but we are, and usually, Q2 is a weak growth quarter. Lookit, in Q2 2019 we grew only 1% on Q1 2019. In Q3 2019 we grew at 8% vs Q2 2019. Again, that incredible acceleration in Q2 2020 distorts the picture. If you look at Slide Four in our investor presentation we walk you through the whole thing in pictures and big font sizes.
Next, we turn to operating leverage. As you all know, we in the edge computing market are in the early stages of our growth and we are using capex to fuel growth. You see it here and at all our competitors, insofar as we have any. We’re delighted to report that we are starting to deliver on that operating leverage. This quarter was our lowest capex spend as a proportion of revenue since we started reporting it. We spent just 5% of revenue on capex - that’s way below the industry average and down on our own trend - but we’re very confident it’s enough to support our ambitious growth plan, which you can see on Slide Five. We can’t promise that every quarter will be that capital efficient, but we can say that our commitment to you is that we will spare no effort into continuing to drive scale economies through this business.
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You get the picture. All the above by the way is absolutely true. The numbers come from the Q2 release and the company’s prior SEC filings. That they couldn’t muster this narrative is further indication of a management team all at sea.
Now, we are long $FSLY in staff personal accounts here at Cestrian Capital Research, Inc. Because we think that whilst there is likely more pain before there is gain, fixing this mess is kind of Get-Hold-Of-It-101, and we think that either this management team or this board of directors or both will be very focused on Getting Hold Of It. So curiously we are rather hopeful for the future of the stock. Not enough to go big. This is a life-is-long story not a YOLO story. But now we sit back and watch. Let the games begin.
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Cestrian Capital Research, Inc - 5 August 2021.
DISCLOSURE - Cestrian Capital Research, Inc staff personal accounts hold long positions in FSLY.
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