A Content Delivery Network (CDN) is a footprint of data center servers that deliver content such as webpages and videos to the user in a secure and fast manner. Almost every major website likely uses a CDN in order to improve the user experience of its website. For example, let’s say a company has a website that is hosted in Tokyo, Japan. If a U.S. resident based in Los Angeles wishes to access the website, they have a couple of options. Without a CDN, the user would make a request (aka a TCP) to access the webpage. However, due to the distance, this can take longer (causing latency) and result in possible security threats. Instead, the company hosts a “copy” or “cached” version of its website at multiple data centers all over the world. Therefore, when a user wants access the site, they can be delivered a faster copy.
This technology is part of the “backbone” of the internet, and given industry tailwinds such as Internet of Things (IoT), artificial intelligence (AI) and the Metaverse, the need for rapid content delivery is more valuable then ever. Even on a baseline, global internet penetration is only at ~60%, and thus developing nations can still improve their CDN spending, according to data from the World Bank.
Thus, in this article, we will take a look at two of the biggest CDN stocks which are poised to benefit from these impressive growth trends; let’s dive in.
1. Cloudflare
Cloudflare (NET, Financial) is the market leader in content delivery networks (CDNs) with a 39.24% market share. This is followed by Amazon (AMZN) CloudFront (part of AWS) at a 24% market share and Meta's (META) Facebook CDN at a 13.79% market share, according to data from Enlyft. Cloudflare's footprint is vast and spans over 275 cities globally, with 95% of the world's population within 50ms of one of its “edge” servers.
Cloudflare is not stopping at CDNs and has build a variety of applications and services directly on top of its platform. This includes its “Zero Trust” service which basically offers an “intelligent switchboard” for the routing of website traffic in a secure manner. In addition, the company’s “Cloudflare One” platform includes a variety of cybersecurity tools such as a firewall as a service and DDoS (distributed denial of services) protection.
Cyber attacks are becoming a growing threat as hackers take advantage of increased connectivity. Therefore, the cybersecurity industry is forecast to grow at a 13.4% compounded annual growth rate (CAGR), reaching a value of $376.3 billion by 2029, according to estimates from Fortune Insights.
Cloudflare is poised to benefit from this trend, and the company even offers a variety of specific application services such as its web application firewall (WAF), which protects APIs.
Growing financials
Cloudflare generated solid financial results for the fourth quarter of 2022. Its revenue was $247.7 million, which rose by a blistering 42% year over year, beating analyst forecasts. The company added on 134 high-ticket customers, which generate the company over $100,000 per year each. This is a testament to Cloudflare's strategy of converting from a network to a “platform” and upselling products to the enterprise, which is a lucrative market. Cloudflare now generates ~63% of its revenue from its larger customer base, which is a positive sign for consistency.
The company also has a net retention rate of 122%, this is fantastic as it means customers are not just sticking with the platform but spending more on its other services.
Moving on to margins, Cloudflare reported a gross margin of 77.4%, which is higher than its historic average of 75%, which is fantastic. However, the company did see its operating loss widened by $9.3 million to $50.7 million as of the fourth quarter of 2021. The driver of this margin squeeze was an operating expense increase of 34% to $257.6 million. The good news is a large portion of these expenses are spend on Sales and Marketing to rapidly expand operations, which I believe is a smart strategy due to the high retention rates in the industry. In addition, its expenses as a portion of revenue has reduced by ~5.4% to 93.8% as of the fourth quarter of 2022. This means Cloudflare’s business is showing signs of economic scalability or operating leverage, which is a positive for its future margin outlook.
Cloudflare is also ahead of the curve with regards to new product security. For example, on March 16, 2023, the company announced it was rolling out “post-quantum cryptography” by default for all its customers. Quantum computing is expected to continue to develop over the next few years and break the majority of traditional encryption methods used online. Therefore, the Biden Administration has made it a mandate for government agencies to prepare for this, and is encouraging private companies to do the same. Cloudflare should benefit from this increased security.
Valuation
Cloudflare trades at a price-sales ratio of 19.77, which is ~48% cheaper than its five-year average.
The GF Value chart indicates a fair value of ~$130 per share and thus the stock is “significantly undervalued” at the time of writing.
2. Fastly
Fastly (FSLY, Financial) is also a CDN provider, albeit a much smaller one. It has ~2,900 customers, which include the New York Times, Stripe and Reddit.
Despite its competitor Cloudflare being much larger, it was interesting to see that Fastly was actually rated higher by Gartner Peer Reviews, with 4.9 stars, which is greater than Cloudflare's 4.7-star rating (out of a possible 5 stars). It will be intersting to see where Fastly's "higher quality" approach takes it.
Financial challenges
The major challenge for Fastly came in 2020, when it lost the rapidly growing platform TikTok as a major customer. The good news is the company has started to recover and reported a 22% increase in its revenue for the fourth quarter of 2022 to $119 million.
Its revenue level means it's roughly half the size of Cloudflare. Therefore, one might expect the company has ~20% market share, using the aforementioned data as a baseline, but I couldn't find any confirmation of this.
Fastly has now started to diversify its customer base much more across ~79 industries, which should be great for lowering the volatility of its revenue.
Similar to Cloudflare, Fastly has a high net dollar retention rate of 119%. This means its customer base is continuing to use the product and spends more on more additions.
Fastly has gradually been reducing its net losses from ~$57 million in the fourth quarter of 2021 to ~$49 million by the fourth quarter of 2022.
Valuation
Fastly trades at a price-sales ratio of 4.6, which is ~64% cheaper than its five-year average. It is also substantially cheaper than Cloudflare.
The GF Value chart indicates a fair value of ~$53 per share, which is lower than its share price as of this writing, but it does warn of a possible “value trap” due to the ongoing unprofitabililty and low financial strength combined with the sharp fall in the share price.
Final thoughts
Both Cloudflare and Fastly are CDN providers which are poised to benefit from the continued growth in connectivity and the cybersecurity industry. Cloudflare is the market leader, has a more extensive product portfolio and is growing faster, thus it is a “better quality" company overall, in my opinion. However, Fastly is substantially cheaper and appears to be more highly rated by customers, thus it may be more appealing from a value perspective.
