While quickly (NYSE: FSLY) announced a strong start to the year, the stock continues its downward trend as investors assess the appropriate balance between financial performance and valuation. During the first quarter, revenue growth accelerated to 21% and beat consensus expectations by nearly 4%.

However, continued margin pressures weighed on profitability, with FCF still burning around $20 million per quarter. At a time when investors are more wary of high-value names in favor of stability and profitability, FSLY could be a while before its turnaround pays dividends.

For starters, the company announced that its current CEO is stepping down, I think that’s a good start for a turnaround story. However, I stay away as this is a demo story that needs to be played out before I become more optimistic.

The stock is down around 65% year-to-date and despite a year-long withdrawal from their network outage, which impacted revenue, churn and sentiment, the stock continues its downward spiral.

To me, the combination of mid-teens revenue growth and lack of profitability doesn’t justify a forward earnings multiple close to 5x. Especially if we enter a recessionary scenario with rising interest rates, there is a risk of falling valuations.

Longer term, FSLY has the potential to be a great turnaround story, although it remains a demo story that needs to run over the next few quarters before sentiment starts to change. Staying on the sidelines for now.

FSLY operates a content delivery network (known as CDN) and makes it easier for consumers to access faster internet by hosting a global network of services and data centers. With their infrastructure being close to the end user, this increases internet response times and reduces latency, providing a better internet experience.

Financial review and advice

The company released its first-quarter results about a month ago, which showed revenue growth of 21% year-on-year to $102.4 million, nearly 4% above expectations for about $99 million. of dollars. Additionally, revenue growth actually accelerated from the 18% year-over-year growth seen in the fourth quarter, which is a positive sign for the company’s growth expectations for FY22.

Non-GAAP gross margin was 52.6% and although down from 60.1% a year ago, management had previously spoken of increased investment in its network to support growth and address supply chain constraints. So optically, yes the gross margin contraction is not large, but at least management made the investment community aware of this dynamic so it was not surprising.

What continues to disappoint is the lack of improvement in profitability. The non-GAAP operating loss was $18 million in the quarter, worse than the $13 million loss a year ago. This is despite revenue growth of nearly $18 million year-over-year.

Low operating margins led to a non-GAAP EPS loss of $0.15 missing consensus by a dime. Yes, it’s only $0.01 missing, but in a time when investors are more focused on profitability, every penny counts.

Another disappointing part of the quarter was the continued burn in FCF. With the company just under $100 million in net cash and burning through $20 million a quarter, something will have to change. Either the company will need to quickly restore profitability or tap into the debt/equity markets for additional funding.

On the positive side, the company now has 2,880 customers, adding 76 net new customers, which is an improvement from 56 net additions in the fourth quarter.

Additionally, Enterprise customers, which account for nearly 90% of the company’s revenue over the past 12 months, continue to grow. The total number of Enterprise customers reached 457 with 12 net additions during the quarter. Additionally, average spend for Enterprise customers reached $722,000, up from $705,000 a year ago and $704,000 last quarter.

This is largely due to the company’s ability to continue selling its services. This is demonstrated by a net retention rate of 114% in the quarter, the highest figure since the fourth quarter of 2020. And let’s not forget that the company’s annual revenue retention rate remains above 99%. , which means customer churn is very low and revenue is very recurring.

For the second quarter, the company expects revenue of $99 million to $102 million, although non-GAAP operating losses continue of about $20 million.

For FY22, the company expects revenue of $405 million to $415 million, representing year-over-year growth of 16-17% and a slight increase from its previous guidance range of 400 at $410 million. While much of this increase is likely due to first-quarter revenue beating expectations by $4-5 million mid-term, it looks like the company could be gearing up for some beat-up quarters and increase.

However, despite the increased revenue forecast, the non-GAAP operating loss for the year was reiterated at $60-70 million, implying slightly lower margins.

Other recent updates

The biggest news of the quarter was that current CEO Joshua Bixby is considering leaving the company. I think it’s a good strategic move, as the company’s shares are down 65% so far this year and around 90% from all-time highs.

While it’s hard to pin all the blame on the CEO, I think a new management team could begin to spark turnaround efforts.

In June 2021, the company experienced a service disruption which resulted in the loss of some customers and negative sentiment around the stock. Since the end of June 2021, the stock is down around 80% and there continues to be a surplus on the stock. Management mentioned that most customers came back quickly, although there was a surplus of a large customer, which would be Amazon.

And I think for a number of those customers, most of them came back within a week or two. We talked about a large customer who took a few quarters to really get back to pre-outage levels.

While the graphs above show the relative market share between Fastly, Amazon, and Akamai, the time frame is only one month, so it’s a bit difficult to extrapolate the long-term implications. However, Fastly seems to be maintaining its market share.

Evaluation

Clearly, sentiment remains negative around the company, with the stock having fallen around 65% year-to-date. Although revenue growth appears to be holding, it has shown signs of slowing. The company just reported its first quarter of revenue over $100 million, but revenue growth was only 21%.

Compared to many other companies, revenue growth above 20% is very strong, however, the stock has historically traded at a high earnings multiple. On top of that, profitability appears to be at least several quarters, if not years, away from actually happening. If we do end up going into a recession, investors might focus even more on profitable companies, which Fastly can’t tick off.

The company has a current market capitalization of approximately $1.5 billion and with approximately $100 million in net cash, the enterprise value currently stands at $1.4 billion. Management’s current revenue forecast for FY22 is $405-415 million, representing 16-17% year-over-year growth. Using the firm’s guidance, this implies an FY22 revenue multiple of approximately 3.4x.

In an optimistic scenario, assume the company significantly accelerates revenue growth to 25% and ends FY23 revenue at $525 million (for comparability, consensus currently expects revenue of 23 of $478 million by Yahoo Finance). This translates to a bullish FY23 revenue multiple of 2.7x.

Even at the valuation level, the title does not seem cheap. There are always profitability issues and with a change in direction coming, now might not be the best time to pile into the stock.

Especially when investors consider that revenue growth may be stuck below 20% (FY22 guidance is 16-17% YoY), with operating margins still having a long way to go to reaching profitability and FCF still burning around $20 million per quarter, there is still a long way to go. to improve.

Longer term, I believe Fastly operates in a great industry and has the potential to be a great stock. Before I get more bullish around the name, there has to be a concrete financial improvement and a successful management transition.