How High Can Cloudflare Go?

Cybersecurity leader Cloudflare, Inc. (NYSE:NET) has received a lot of attention in recent years as it became a leading name in website and internet infrastructure protection. Over the past 5 years alone, NET share price is up 319%.

The company features a wide variety of offerings including a content delivery network (CDN), DDoS mitigation, and internet security among other services, all of which are important in boosting client’s online presence, performance, security, and stability.

While the stock enjoyed a strong run last year, it ran into some troubles more recently and has largely struggled to gain traction this year, so what’s next for this former high flier?

What is Cloudflare’s Growth Plan?

Cloudflare’s growth strategy is both a function of new customer acquisition at all plan levels (contracted, pay-as-you-go, and free plans) as well as extending relationships with the existing client base.

Customer engagement is a key strategy for the firm to encourage existing clients to upgrade and expand the existing customer base through cross-selling.

In addition to expanding existing offerings, Cloudflare is developing new products optimized for its ever-widening network footprint, benefitting both existing and potential customers.

Plus, it supports the current market’s inclination toward developer-based solutions like Cloudflare Workers, which mainly focuses on storage and computing services.

By the end of 2023, Cloudflare had a total of around 190,000 paying customers from 120 countries around the world.

The highly diversified customer base covers organizations of various sizes across major sectors including technology, healthcare, financial services, consumer and retail, industrial, non-profit, and even government.

Of particular interest is the number of large customers, which have increased from 1,416 in December 2021 to 2,042 in December 2022 and then further to 2,756 in 2023.

It’s also comforting to see the lack of exposure to a single account. Indeed, none exceeded 10% of sales over the past three years.

Are Growth Forecasts Already Priced In?

Cloudflare has been reporting losses for some time and the turn to profitability remains in doubt.

The bottom line has been negative in recent years, although increasingly less so:

  • 2023: $183.9 million
  • 2022: $193.4 million
  • 2021: $260.3 million 

All told, an accumulated deficit of $1.02 billion has formed as of December 31, 2023.

Operating in such a competitive market has demanded the firm stretch its operational capabilities both domestically and internationally, but it’s come at the cost of the bottom line.

However, the top line has benefitted from the spending:

  • 2023: $1.30 billion
  • 2022: $975.2 million
  • 2021: $656.4 million 

Nonetheless, the rate of revenue growth has declined from 52% in 2021 to 48.6% in 2022 and further to 33% in 2023.

For the most recent quarter, which ended on March 31, 2024, total revenues grew by 30% versus the same period in the prior year to $378.6 million. Net losses of $35.5 million were reported compared to $38.1 million in Q1 2023.

On the other hand, its non-GAAP net income was $58.2 million compared to $27.2 million in the prior-year quarter.

While it has been delivering better performance in recent quarters, struggles have arisen from market saturation and stiff competition. 

Management is burdened with the ever-challenging balancing act of needing to invest heavily to win market share while not spending too much so as to threaten the balance sheet liquid reserves.

Cloudflare’s Competitive Landscape

In the network services market, Cloudflare competes in multiple categories. Against on-premises network hardware vendors, Cloudflare focuses on multitenant, cloud-based services with security, performance, and reliability designed for the cloud-dependent space.

Secondly, Cloudflare competes with its point solution vendors, offering cloud-based products that address the particular needs of security, CDN, DNS, email security, and cloud SD-WAN.

As an integrated infrastructure platform provider, Cloudflare provides a full suite of solutions for security, performance, and reliability needs of clients that match their preferences.

Lastly, the company competes with an array of services provided by legacy public cloud providers. It helps users to manage different infrastructure environments while also eliminating vendor lock-in. 

With Cloudflare’s aim of extending its serverless platform to third-party developers, it becomes a potential competitor to the public cloud vendors for storage and computing workloads.

The Cloudflare Workers’ efficiency and distributed nature result in a competitively-priced offering that enables applications that were previously not feasible on traditional public cloud platforms.

While competition is apparent, Cloudflare is confident of its strengths, and it believes it is positioned well against competitors.

Cloudflare Price Target

The consensus Cloudflare price target among 28 analysts is for NET share price to rise to $88.61 per share.

Despite the fact that the company’s losses have persisted, analysts are increasingly optimistic with 15 upgrading their forecasts for earnings in the next reporting period. For the coming year, they forecast the company will turn the corner to profitability also.

One reason for the optimism is the continued high gross margins of around 76% with which the company operates. A second is the expectation that net income will begin to persistently improve.

With all that said, Cloudflare’s valuation based on non-GAAP forward earnings of 120.84x is inflated relative to that of its peers. Also, the stock is trading at 15.24x forward sales, over 400% higher than the industry median. 

High multiples combined with heightened competition and the dynamic nature of the business environment create uncertainty but the recent trend suggests that fears may be elevated and the future may be bright for this category leader.

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