Cloud services vendor Cloudflare (NET) has grown at a tremendous pace since its initial public offering in 2019. The company increased revenue by 240% over the last three years, while its share price climbed 290%. Even so, Cloudflare has hardly scratched the surface of its addressable market, though it is gaining momentum in several cloud computing areas.
To that end, management expects revenue to grow fivefold in the next five years, and that could easily translate into fivefold returns (i.e., 400%) for shareholders, especially when revenue and share price have grown in lockstep for the last three years. But even if those returns fail to materialize in that time frame, this magnificent growth stock is still worth buying.
Here’s why.
Cloudflare has a durable competitive advantage
Cloudflare provides application, network, and cybersecurity services that protect and accelerate business software and IT infrastructure while eliminating the cost of physical network hardware. Cloudflare also offers computing and storage services through its developer platform (Cloudflare Workers) that allow businesses to write code and build applications on its network.
Vendors like Amazon Web Services (AWS) and Microsoft Azure undoubtedly dominate the cloud computing industry, but Cloudflare is growing more quickly. Its revenue increased 49% to $975 million last year, and non-GAAP net income climbed 160% to $0.13 per diluted share. More importantly, Cloudflare benefits from two key advantages that should sustain its momentum for many years to come.
First, Cloudflare operates the fastest cloud network and developer platform on the market. That advantage arises from its superior architecture. Cloudflare shares a direct connection with every major internet service provider, cloud vendor, and enterprise, which allows its network to deliver content to 95% of global internet users within 50 milliseconds. That speed made Cloudflare popular with customers, and it carried the company to the top of several cloud categories, including content delivery network (CDN) software and edge development platforms.
Second, while Cloudflare is smaller than Amazon and Microsoft, its unmatched speed and freemium pricing strategy resulted in greater scale in certain areas. For instance, Cloudflare handles nearly 18% of all internet traffic, and it provides security services to more than 20% of the web. The data generated by providing those services gives the company great insight into performance issues and security threats across the internet, which it can use to improve products and inform development decisions. Ultimately, that data advantage creates a network effect that should draw more businesses to Cloudflare.
Cloudflare is chasing a massive market opportunity
Cloudflare management estimates the company’s addressable market at $125 billion. Two products — Cloudflare Workers and Cloudflare One — account for a big chunk of that figure, and the company is well positioned to capitalize on both opportunities.
Cloudflare Workers: In 2021, Forrester Research recognized Cloudflare Workers as the leading edge development platform, and the product has only become more compelling since then. Cloudflare now offers two complementary storage solutions: R2 object storage for unstructured data (e.g., photos, videos) and D1 database for structured data. Those storage solutions make Workers an even more compelling option for developers.
Specifically, R2 eliminates egress fees in certain situations, meaning developers can access data without being charged. The company believes R2 is 10% less expensive than the industry standard, S3 from AWS. Similarly, D1 is a fully managed database, meaning developers can build applications without worrying about the underlying storage. To that end, CEO Matthew Prince expects D1 to “quickly become one of the largest databases in the world.”
Cloudflare One: Cloudflare is gaining momentum in zero-trust security. The company was recently recognized as a leader in web application firewalls by Forrester Research, and it was recognized as a leader in web application and API protection by Gartner. More to the point, as discussed earlier, more than 20% of the web relies on at least one Cloudflare security service. That positions the company to upsell existing users with its secure access service edge (SASE) product, Cloudflare One.
SASE platforms like Cloudflare One are the future of enterprise networking and security because they streamline digital transformation and enable remote work. Specifically, SASE products allow users to quickly and securely access the open internet and business resources (i.e., software, data) from any device or location. With that in mind, Gartner estimates that 80% of enterprises will be using SASE products by 2025, up from 20% in 2021.
The stock trades at a reasonable price
Cloudflare stock currently trades at more than 20 times sales, a discount to its three-year average of 42 times sales. That valuation is certainly not cheap, but it is reasonable in context. Management says the company can achieve fivefold revenue growth in the next five years organically, which means that the estimate is based solely on its current portfolio. Any new products built during that time could further accelerate growth, and Cloudflare has a track record of bringing products to market quickly.
With that in mind, investors should expect revenue to grow more than fivefold in the next five years, and that could easily lead to fivefold growth in the share price as well. That’s why this stock is worth buying today.
— Trevor Jennewine
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Source: The Motley Fool