Note from Daily Trade Alert: The following article first appeared in The Growth Stock Advisor, a premium newsletter offered by Investors Alley.

A few weeks ago, the whole world became aware how our internet-connected society is dependent on a mere handful of companies after a glitch caused a big chunk of the internet to drop offline in early June.

Sites affected by the glitch included Amazon (AMZN), the BBC, the New York Times (NYT), Reddit, Pinterest (PINS), the UK government website, and the Financial Times. The outage was triggered when one customer of one company—Fastly (FSLY)—changed its settings, revealing just how many crucial parts of the internet’s infrastructure are vulnerable and concentrated in the hands of just a few suppliers.

The good news was that Fastly was not caught napping on the job. It detected the disruption within one minute, identified the cause, and disabled the configuration relatively quickly. In less than an hour, 95% of its cloud-based network was operating normally.

What Fastly Does

The global reaction to this event, including on Wall Street, was: What the heck is Fastly? Few had even heard of the company despite it being listed on the New York Stock Exchange since May 2019.

Fastly is what is known as a cloud-based content delivery network (CDN) provider. A CDN is a widely geographically distributed group of servers, which work together to provide fast delivery of online content. Companies use CDNs because they offer not only speed of response for users of the website, but also protection against distributed denial-of-service (DDoS) cyberattacks. These attacks are easy to mount against a website if its servers are in just one location.

I want to highlight to you the importance of the speed of a website. Several studies show how bad it is for businesses to have slow or unresponsive websites. According to Loadstorm, the cloud testing tool, 25% of people will abandon a website if it takes more than four seconds to load, and nearly 75% will abandon a mobile site that doesn’t load within five seconds. Also, 46% of users won’t return to a poorly performing website.

Companies in the real world back up those studies. Pinterest said that when it reduced user wait times by 40%, its search engine traffic and user signups each increased by 15%. Fast Company cited tests that found that Amazon would lose $1.6 billion in sales annually from a one-second page load slowdown, and Google would lose eight million searches per day if its results were four-tenths of a second slower!

That’s why CDNs are so crucial to companies in today’s world. But the risk is that if the CDN goes down, so does your website. Add it all up and this translates to CDN clients being very “sticky”—good news if you’re a company offering CDN services like Fastly.

The CDN Market

As global data volumes expand exponentially, there is more of a need to protect it. That means CDN is definitely a growth business.

Last year, the CDN market was valued at $11.8 billion. The research firm Mordor Intelligence expects the CDN market to grow by leaps and bounds to nearly $50 billion by 2026. That’s a compound annual growth rate (CAGR) of 27.3%!

The pure-play, leading CDN providers are Fastly, Cloudflare (NET), Akamai (AKAM), and Limelight (LLNW); however, these companies are not alone. Two tech giants, Google parent Alphabet (GOOGL) and Amazon, also have a CDN product, and are chasing the pure-play providers. Amazon’s cloud computing business, Amazon Web Services (AWS), has its own CDN service, CloudFront, but still uses Fastly in part of its network.

Despite the heady growth, the industry faces a problem: profits are nonexistent and losses are widening. The one exception is the senior citizen of the group, Akamai. It is consistently profitable and has an excellent EBIT margin of around 20%.

Fastly’s other competitors, Cloudflare and Limelight, are losing money, as they prioritize chasing greater scale and top-line growth.

Cloudflare even goes so far as saying that it “…may not be able to achieve or sustain profitability in the future.” And this is despite high gross margins—averaging 76.5% over the past five years—and its cash-generating subscription model.

A Closer Look at Fastly

Fastly, is in the same boat: in May, the company lost more than a quarter of its market value! That was due to its forward guidance of flat growth in the next quarter, with revenues in the $84 million to $87 million range. And it’s likely still a year or two away from generating free cash flow.

However, Fastly’s services are essential and different than Akamai’s. Fastly is designed to serve its customers at its edge servers, avoiding trips to the origin servers. It allows developers to write code for the edge servers, so if content on a website has short shelf-life, the changes can be handled directly on the Fastly servers.

If Fastly customers need to authenticate whether their own customers should have access, they can do it from a Fastly server rather than from their own servers. The same goes for e-commerce, personalized searches, and live streaming of major events.

I believe that the ability to compute at Fastly’s edge servers will open a revenue stream for the company that has been previously untapped by other CDN firms and from a market that’s many times bigger than the traditional CDN market. Its focus on catering to its customers’ developers’ needs will prove to be a winning strategy longer-term.

The adage that any publicity is good publicity certainly applied to Fastly. After the bad news about the outage, the stock was “discovered” by Wall Street and promptly moved up by about 20%…although that still left it well below its February high of $118 a share.

I rate Fastly as a 4-star stock—it has too much competition to be a 5-star stock. It can be bought at any price up to $75 a share.

— Tony Daltorio

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Source: Growth Stock Advisor