Recent IPO Cloudflare (NET -1.47%) reported third-quarter 2019 results on Nov. 7 -- its first scorecard as a public concern. Though the cybersecurity industry is becoming a crowded one, the upstart enterprise has been able to maintain its pace of expansion thus far. With its cloud computing-based operations giving it a leg up on the incumbent competition for the time being, the most recent update provides more reasons why this newly public company is at least worth putting on watch lists.
The first quarter in the public spotlight
Revenue in Q3 increased 48% year over year, matching the pace of expansion Cloudflare put up during the first half of the year. Gross profit margin on product and services rendered also increased by 0.7 percentage points to 78.3%, in keeping with what's to be expected from a relatively small subscription-based revenue operation -- although losses mounted as Cloudflare continued to spend its way to growth in the hopes of a bigger bottom-line payoff later.
Here's how the year is shaping up when adding all three quarters together.
|
Metric |
Nine Months Ended September 30, 2019 |
Nine Months Ended September 30, 2018 |
Change |
|---|---|---|---|
|
Revenue |
$203 million |
$137 million |
48% |
|
Operating expenses |
$236 million |
$174 million |
36% |
|
Net earnings (loss) |
($77.7 million) |
($70.5 million) |
N/A |
|
Adjusted net earnings (loss) |
($53.1 million) |
($43.8 million) |
N/A |
Pp = percentage point. Data source: Cloudflare.
What's behind the company's big top-line gains? Making the transition to the cloud has been a big priority as organizations around the globe use cloud networks to fuel their operational changes. However, the need for simplicity is important, and a vendor that can solve multiple problems is a key way to achieve it. Cloudflare is just such a vendor, offering web content management and delivery services, security, and software developer tools, among other things.
Speaking to his company's strategy with its large suite of services, CEO Matthew Prince had this to say on Cloudflare's earnings call:
Our strategy is to get to market quickly with early adopters, gather feedback from those first customers, and then iterate quickly to move up-market, serving larger and larger enterprises over time. That's why it's powerful that we have a broad set of total customers, more than two million across our free and paying segments, which provide a test bed to build great products and meet the needs of the largest enterprises. Today, we count more than 10% of the Fortune 1000 as paying customers, and last quarter, our large customer count -- those customers that spend more than $1,000 per year with us -- increased 71% year-on-year to 475.
Image source: Getty Images.
Living up to expectations
As for outlook, Cloudflare said it expects full-year 2019 revenue to come in at $281.5 million to $282.5 million, a 46% increase from 2018 -- not a bad rate of growth at all. Clearly the company's strategy of starting with small customers and building from there is working. However, expected revenue relative to Cloudflare's current market capitalization of $4.85 billion does place it at a premium. Based on expected 2019 results, Cloudflare currently trades for 17.2 times sales -- a hefty price tag, but less than what other cybersecurity outfits currently go for.
With Cloudflare still operating in the red, it's hard to put a good valuation on it at this point. Thus, the real question for investors is whether the security and web delivery platform can maintain its high rate of growth for the long term. Cloudflare's strategy of going after smaller businesses and releasing products for free until they are perfected for bigger players is certainly a unique take, and it's one that has worked thus far. Internet traffic isn't going to get less congested anytime soon, so that's also a positive working in this start-up's favor.
So there's the trade-off. Cloudflare is a high-growth and high-potential stock, but for primo pricing. With its first quarter as a public company in the books, Cloudflare's results make me think it's worth at least keeping an eye on. However, anyone interested in a buy should follow the typical rule with high-octane growth, but loss-making businesses: Keep initial purchases small, and add to the position over time (like monthly, quarterly, etc.) since volatility is likely to stick around for the indefinite future.
