Cloud companies have performed well this year, as the Covid pandemic has forced companies, schools and governments to tap new options to keep operations going while people stay home. Within the high-flying BVP Nasdaq Emerging Cloud Index, up 98% so far in 2020, the top-gaining stock is Zoom, which has grown 483% this year as millions of people came to rely on its video-calling software.
The next two companies in the index that come closest to Zoom’s performance are not nearly as well known: Cloudflare and Fastly. Rather than provide services to consumers, their products work in the background and enable images, videos and text in websites and mobile apps to load quickly. Their clients pass content to Cloudflare and Fastly’s facilities, which are located in data centers around the globe so that it doesn’t take long to pass it on to end users.
Cloudflare stock is up about 380% for the year, and Fastly shares are up 373%.
That doesn’t mean the entire market for content distribution networks, or CDNs, is hopping. Industry leader Akamai, founded in 1998, has risen about 20% this year, compared with the S&P 500’s 13% gain over the same period.
Even if it’s not skyrocketing like the newcomers, Akamai is having a relatively good year. In the second quarter Akamai’s revenue increased 13% year over year, and in the third quarter it was up 12% — a sharp contrast from the sub-10% growth it’s experienced since 2015. That’s elevated growth for the company, partly thanks to more internet traffic than usual, as people bought products online, streamed movies and downloaded video games from their homes to reduce spread of the coronavirus.
By way of comparison, Cloudflare’s revenue rose about 48% on an annualized basis in the second quarter, and the growth accelerated to 54% in the third quarter. Fastly, for its part, delivered 62% growth in the third quarter, and it slowed to 42% in the third quarter.
Traffic flood
The gains have not come without challenges. Cloudflare ran into problems getting equipment from its Asian suppliers early in the year. Then came the traffic flood.
“In late March, traffic across our network spiked as the world shifted to working from home. In two weeks, we saw more than 50% growth in traffic, more than we had forecast for 12 months.” Cloudflare’s CEO and co-founder, Matthew Prince told analysts on a conference call in November. The company has accumulated 100,000 paying clients, with nearly half of its revenue coming from outside the U.S.
Fastly stock got beaten down early in the pandemic because it does business with travel companies such as Alaska Airlines and JetBlue, according to Rishi Jaluria, an analyst at DA Davidson. But that changed, especially after it delivered more revenue in the first quarter than analysts had expected. Fastly stock jumped about 46% the next day.
Investors are paying rich premiums for the younger companies’ growth. Cloudflare and Fastly are trading at, respectively, 48 times and 31 times their expected revenue over the next 12 months, while Akamai’s multiple is just five.
The promise is these companies will take market share from staid competitors. Akamai controlled 42% of the CDN market in 2019, according to an estimate from technology industry research firm IDC. After Akamai, ChinaNet Center held 13% of the market, while Verizon had about 5% and Lumen (formerly known as CenturyLink) and Limelight Networks each had almost 3%.
What’s more, Cloudflare and Fastly are going after a nascent market known as edge computing, which enables applications to run faster by being closer to users. Those companies can benefit if demand for edge computing takes off and they can take meaningful market share, Jaluria told CNBC. He estimates that edge computing represents less than 10% of revenue for Fastly, a stock on which he has a buy rating.
Fastly operates its CDN more efficiently than Akamai while using fewer computer servers, and Fastly is more friendly to developers than Akamai, Jaluria said. He said Fastly boasts growing customers such as Shopify and Spotify, as well as video-sharing app TikTok.
Akamai counts Airbnb and Epic Games as customers, along with Microsoft and Sony, which are both are selling new video game consoles this holiday season, said Ari Weil, vice president of product and industry marketing at Akamai. Unlike Fastly, Akamai doesn’t display prices on its web site. But Weil noted that Akamai provides tools to help programmers get started quickly, and has servers in place to provide better performance outside major markets.
There’s also the possibility that these fast-growing upstarts could be sucked up by bigger enterprise players, giving their stocks another bump. On Tuesday, Fastly stock rose almost 15% following speculation about a possible acquisition by Cisco. While Fastly’s business is growing, unlike Cisco, Cisco would have to pay a premium to get it.
But Jaluria said he doesn’t think Fastly would want to sell to Cisco.
Cisco’s track record with software companies it has bought is “less than stellar, to put it nicely,” Jaluria said. “Look at the state of Webex today, versus Zoom.” Eric Yuan once worked on the Webex video-calling technology that Cisco bought in 2007; he left Cisco and started Zoom in 2011.
