Cloudflare: a closer look

Cloudflare (NET) has become a lot of things that different investors are familiar with. Investors classify Cloudflare as a cloud or network security company, content delivery network [CDN] or identity access management [IAM] company. The fact is that although Cloudflare is involved in all of these, the company’s operations are actually much larger. Cloudflare regards itself as “a network company”, “you have to think about [Cloudflare] almost like Cisco-as-a-service. Anything where you would have bought and acquired hardware on-premise, whether it’s firewalls, routers, load balancers, VPNs, we offer this as a service from our network. And this network is masked by now.”

In fact, CEO Matthew Prince emphasized: “So the reason that we picked the ticker symbol NET was because, fundamentally, what it is that we sell is the network that you plug into and then you don’t have to worry about anything else. And so that’s what we want to deliver. And so a piece of that is you want to make sure you have a fast network. A piece of that is you want to make sure you have a reliable network. But a big piece of that is you want to make sure that you have a network which is helping you solve the security problems that you have.”

One of the key reasons Cloudflare wanted investors to clearly understand the company’s business scope is to allow investors to have an appropriate strategic view of the company’s still expanding TAM. The company emphasizes that it has been expanding since its initial public offering in 2019. Although the company It started with a TAM of $37B in 2019, and then saw it was revised upwards to $72B, but now the company is looking for a TAM of $100B in the next 3 years.

Leader in DDoS security

Although Cloudflare started with “load balancing, firewall, DDoS mitigation services” and became the undisputed global market leader in DDoS protection with an 81.4% market share, the company has quickly expanded its TAM to VPN and remote browser isolation service (through its acquisition of S2 Systems Corporation on January 20) targeting these two markets through Cloudflare for Teams and the browser isolation service (which can also be added to its Teams product). However, in its third TAM expansion, the company planned to “disrupt enterprise networks and multi-protocol label switching [MPLS]” through its Cloudflare Magic Transit product. By protecting the company’s on-premises data centers, the company seeks to disrupt Ciscos (CSCO) and Fortinets (FTNT) and Check Points (CHKP) and Palo Altos (PANW) and Riverbeds of this world.

Therefore, investors should be able to clearly recognize the extreme scalability of Cloudflare’s business model and its ambition to compete locally with the largest internal security players in the market. Magic Transit will be a key player in the company’s penetration of its corporate sector, because “MPLS spending is an important dollar item in our client’s budget” will help the company build its corporate sector that has been growing rapidly.

The rapid growth

The company has undoubtedly made great progress in the enterprise field, which is now the company’s “fastest growing business.” Although as of the first quarter of 21, its 945 corporate customers (compound annual growth rate of this segment increased by 69% compared to the first quarter of 2018), it pales in comparison to its total number of customers of 119,206, but this segment now represents most of the company’s revenue. Cloudflare further added: “Let’s look at customers who provide us with more than $500,000 or even more than $1 million per year. The larger the queue, the faster the growth. Therefore, our largest paying group, customers over US$1,000,000 have been growing at a rate of more than 70% in the past 7 quarters.”

DBNRR preservation

Although investors may have been overwhelmed by the number or scope of the products or services the company provides to customers, Cloudflare emphasizes that, in fact, “First of all, the more products we have, the easier it will be to expand.” The company has of course been paying attention to building. It provides products of important value to its customers, and has seen its customers rise rapidly on the product adoption ladder for many years.

Importantly, the company has attached a “magic number” to its customers’ product adoption rates: 4 products per customer. It emphasized that although at the time of the IPO, 70% of customers each used 4 products, “this number is now far more than 80%. Now more than 70% of customers are using 5 products. Therefore, as the product number increases, we are able to sell more products to existing customers.”

For many years, the company has kept its DBNRR unchanged, and in the past 3 years, it announced the most impressive DBNRR in the first quarter of 21, reaching 123%. Although its DBNRR is consistent with the median of its SaaS peers at 120%, we are confident that as more and more customers adopt more products, the company will continue to maintain the consistently high level of DBNRR, “and, [ Lead to] product stickiness and [have] drop in attrition rate.”

Cloudflare was never designed as a CDN

Many investors often compare Cloudflare with Fastly (FSLY) as competitors in the content delivery network (CDN) space. Although NET can definitely compete with FSLY in this field, the company especially wants to remind investors:

“We were never designed as a CDN. We had to provide CDN-like functionalities in order to deliver security and performance-based products and services at the edge of our network. But CDN was a means to achieve that, but not the business model in itself. We are pricing our products differently. We have no usage — or hardly any usage-based pricings. Even today, less than a low single digit of our revenue is variable billing-based. And of that, less than 1/3 is really bandwidth-driven.”

We recently emphasized and reminded investors in an article about FSLY that FSLY is not a typical SaaS model, because the company’s revenue mainly comes from usage, not subscription. On the other hand, most of NET’s revenue comes from subscriptions, so the revenue models that drive their respective businesses are completely different.

In fact, the unpredictable bandwidth cost based on the usage model is one of the key reasons why NET chose not to adopt the usage-based revenue model, because the company hopes to focus on reducing customer costs and provide it in a “predictable and reliable way.” Cloudflare’s priority would then turn to finding ways to “drive the cost of bandwidth to close to 0 over time” by making sure its “software-defined network could allow any server anywhere in our network to run any different function that we did and to be able to shift traffic around to deliver a level of efficiency that no one else has.”

CEO Matthew Prince also added: “So I think a typical CDN company is worried about how many people will watch the Super Bowl, whether the new shows on Disney+ will be popular, and I worry about the new network “from Russia or Iran, threats from all over the world, and how to stay in front of these threats. Again, just a completely different business. “

Therefore, investors can rest assured that the kind of fluctuations in usage that FSLY endures when it loses a major customer, as was seen with TikTok, is unlikely to happen to NET, because Cloudflare does not bill for usage, thus providing the kind of revenue visibility expected from a typical SaaS company.

However, compared with FSLY’s usage-based billing model, Cloudflare’s subscription-based revenue model is not without its inherent disadvantages, as long as customer usage surges, as the company experienced during the pandemic last year:

“Suddenly, we saw a sharp rise in the amount of bandwidth people use in our services, and a sharp increase. Unlike traditional CDNs, we cannot pass these costs on to our customers. So those actually, I think , It is quite a big headwind for us, I really adjust for our team, solve customer problems, focus on expanding our existing customers and making them bigger customers and becoming more efficient over time I am proud of it. So I think that the headwind for us has now become the tailwind. We see that the bandwidth usage has stabilized, which is very attractive to the cost of our business.”

Profit margins

Although the company had to deal with the dramatic increase in bandwidth costs that its subscription model was not designed for last year, it still managed to keep its gross profit margin above 75% over time, which could easily exceed the usage rate of FSLY Based on revenue model. The company’s full set of network products help the company achieve strong diversification of its revenue base, which further proves the company’s business model’s excellent execution in multiple markets and industry verticals, and strengthens its revenue against any unexpected slowdown or unexpected The cost of flexibility has skyrocketed. If investors call Cloudflare a “jack of all trades”, then it can also be called a “master of all” too.


Although NET has not yet achieved FCF and EBIT profitability, the company has guided a long-term operating margin of 20%. This is very easy to achieve over time because it is expected that the company will achieve 15.7 % Of EBIT margin by the end of FY25, especially when the company is still expected to achieve rapid revenue growth of more than 30% in the next few years.

The confidence mainly depends on the continuous improvement of the company’s operating leverage demonstrated in its SG&A profit margin, which is the company’s largest operating expense component. The company may continue to maintain this improvement, which will significantly reduce its EBIT margin and enable the company to achieve EBIT and FCF profitability in the next few years. Therefore, the NET party must have just begun.


The market valuation of NET’s EV/FY+1 Rev is 52x, while the average for the past year is about 35.5x. Based on calculation of the expected revenue growth rate of NET in the next few years is an expected 4-year compound annual growth rate of 19.66% for the stock price. Even at the current price level, if the company can maintain its excellent execution record and achieve its Growth target.

Based on the current price trend, there is no best entry point for new investors, even if based on the current price level, NET may continue to outperform the market. Therefore, investors who do not consider price actions can enter the market now if they have high confidence in the execution of NET in the next few years. Those considering price movements in their decision-making should wait for the retracement first.

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