Is Cloudflare Stock Undervalued?

During the first three quarters of 2023, Cloudflare, Inc. (NYSE:NET) managed to grow customers by 34% year-over-year. 

By the end of last year, it supported approximately 20% of the digital world, ranging from mobile apps, APIs, corporate networks, and AI infrastructure thanks to millions of customers, including around 30 % of Fortune 1000 companies.

Cloudflare also serves small and medium businesses, non-profit organizations, government institutions, and leading artificial intelligence companies.

The company’s impeccable ability to identify major cyber threats has demonstrated its cutting-edge ability while its AI infrastructure enhances its competitive advantage.

As demand demand grows for digital infrastructure and cybersecurity products, the future is looking even brighter for Cloudflare but sometimes share price gets ahead of fundamentals, so is that the case, or is a deal still on to be had?

Cloudflare vs Competition

As Cloudflare expands its own product suite, it naturally is encroaching on other companies. For example, it competes with on-premises networking hardware suppliers that have multitenant cloud-based security services.

It also steps on the toes of point solution vendors who offer cloud-based security, CDN, email security, DNS, and cloud SD-WAN technologies.

Because Cloudflare can be customized to the needs of customers depending on their safety, efficacy, and reliability needs, it competes with public cloud providers too.

Any rival offering to manage different infrastructure environments and focusing data privacy is in its crosshairs too.

How Are Cloudflare’s Financials?

The bad news for value-oriented investors is that Cloudflare has been reporting persistent losses and profitability remains in doubt.

The bottom line has been in the red for a few years now:

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

Over the years, these figures collectively have contributed to an accumulated deficit of $1.02 billion as of December 31, 2023.

Given the fierce competitive landscape, Cloudflare is focused on top line growth and that’s stretching operations both domestically and internationally.

The result is positive in some respects, for example, expanding infrastructure and introducing novel products. But commensurate with those pluses are the minuses of higher costs.

Speaking of the top line, though, it has been growing well:

• 2021: $656.4 million
• 2022: $975.2 million
• 2023: $1.309 billion

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

A positive was the fact that non-GAAP net income was $58.2 million, compared to $27.2 million in the prior-year quarter.

While management has been delivering better numbers in recent quarters, they have struggled due to issues relating to market saturation. The fine balance between managing operating costs as they expand and sustaining growth is the focus of Wall Street.

Is Cloudflare Stock Undervalued?

Cloudflare stock is 13.5% undervalued according to the consensus forecast of 28 analysts who have a price target of $88.61 per share. A 5-year discounted cash flow forecast analysis is less optimistic with a fair value price of $71 per share.

Which number is correct may largely be answered by how Cloudflare staves off competition from AWS, Microsoft Azure, and Google Cloud.

In spite of strong sales growth, profitability remains an issue for the company due to rising operating costs, which have put pressure on margins.

The current price suggests Cloudflare is richly valued and approaching the ceiling of full valuation. For example, non-GAAP forward earnings of 116.99x is much higher compared to its peers. Also, the stock is trading at 14.79x forward sales, over 400% higher than the industry median.

Still, there may be a little more juice to squeeze out of the lemon before a correction takes place.

AI Capabilities a Key Focus For Cloudflare

In its Developer Week 2024, Cloudflare unveiled a number of significant updates and new features, including some for its serverless Workers platforms, AI-based additions, and storage capabilities.

Cloudflare is increasing the accessibility of AI technology for developers with GPU-enabled infrastructure and model-serving on its edge network, where any developer can use Cloudflare AI with a simple REST API call.

First launched in 2017 as part of the company’s Edge Computing product suite, Cloudflare Workers allows users to create JavaScript Service Workers that execute at the network edge.

At the end of last year, management lifted the veil on plans to bring Nvidia GPUs into more than 100 cities to power its ‘Workers AI’ service for generative AI workloads. The target is expected to be met within one year through deployment across most of the firm’s networks in more than 300 city data centers.

Although it is originally a content delivery network, or CDN, operator, Cloudflare has been gradually expanding its services into broader networking and security solutions. Currently, it is gearing up to expand into the AI inference market.

Cloudflare is managing with the growth of generative AI by adding the following three new AI support components on its Workers platforms:

• Workers AI, which runs on NVIDIA GPUs with a pay-per-use model;
• Vectorize, being a vector database designed for efficient vector indexing and storage; and
• AI Gateway that offers caching, rate limiting and monitoring for AI deployments.

To integrate GPU infrastructure and foundation models into its edge network, Cloudflare partnered with NVIDIA, Microsoft, Hugging Face, Databricks, and Meta.

What Is Cloudflare’s Service Partner Strategy?

Cloudflare’s global network, which connects ISPs, major cloud services, and companies has a wide presence in 120 countries. This comprehensive network supports a wide range of products, including security, performance, reliability, web development, AI, corporate access management, and creative products.

Cloudflare’s customers are from different sectors across the globe, and millions of users require specialized and flexible solutions. As a result, Cloudflare has developed partner service programs in which partner service providers with localized expertise and technical skills are working together to address the requirements.

The Authorized Service Delivery Partner (ASDP) program is an embodiment of this strategy after onboarding partners to ensure the quality of service.

Management has stated plans to expand its service provider program, including by making the portfolio for Authorized Service Delivery Partner (ASDP) wider through networking as well as edge services and having a specialization for Managed Service Providers (MSPs) that allows them to integrate Cloudflare into managed security services.

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The author has no position in any of the stocks mentioned. Financhill has a disclosure policy. This post may contain affiliate links or links from our sponsors.