After rising 20% after its debut as a public company in September 2019, Cloudflare (NET +1.10%) hasn't been able to hold on to any positive traction since. There are reasons for that, including a premium valuation factoring for continued double-digit sales growth and a lockup period on shares expiring the first half of March 2020 (which could trigger share price declines if too many of those shareholders decide to sell). Nevertheless, the cloud computing and internet security outfit has a unique growth strategy and plays in a fast-growing industry, and is thus worth a look after delivering a strong end to 2019.
Q4 by the numbers
During the final quarter of 2019, Cloudflare's sales accelerated from the pace set during the first nine months of the year. Revenue increased 51% to $83.9 million, and adjusted gross profit also grew as the company added more customers to its lineup of cloud-based web delivery and security services. In total, Q4 helped Cloudflare notch a 49% increase in revenue in its first year as a public concern, and adjusted net losses for full-year 2019 were $69.5 million compared with $59.5 million in losses in 2018 as cash was funneled back into the business to maximize growth.
|
Metric |
Three Months Ended Dec. 31, 2019 |
Three Months Ended Dec. 31, 2018 |
Change |
|---|---|---|---|
|
Revenue |
$83.9 million |
$55.5 million |
51% |
|
Adjusted gross profit margin |
78.7% |
76.9% |
1.8 pp |
|
Operating expenses |
$95.7 million |
$59.6 million |
61% |
|
Adjusted net earnings (loss) |
($16.4 million) |
($15.6 million) |
N/A |
Pp = percentage point. Data source: Cloudflare.
Of course, not all investors are going to be comfortable with a company that intentionally operates at a loss, and that is forecast to continue that way. Adjusted operating losses (which back out one-time expenses and noncash stock-based employee compensation) are expected to be $65 million to $61 million in 2020 as Cloudflare continues to invest in new services and foster sales. The upshot, though, is that the 2020 revenue outlook for $389 million to $393 million implies another 36% increase over 2019 at the midpoint, and the company is well funded to support its ambitions with $637 million in cash and equivalents in the bank.
Image source: Getty Images.
Helping organizations migrate to the cloud
Based on those expectations, Cloudflare stock trades for 14 times one-year forward sales. It isn't cheap, but it is a relative value compared with some of the other cloud-native software and security providers that went public in 2019. And there is plenty of room for the company to keep growing at the rates it has been.
Cloudflare has taken a different approach to promoting its services, starting with small businesses and fellow start-ups to try out its web delivery, edge network, and cybersecurity offerings -- often for free. As the products are perfected, Cloudflare then moves upmarket with its software and starts picking up larger paying customers. It's the opposite approach to the one most cloud vendors utilize these days, but it's been working. CEO Matthew Prince said that the company ended the year with 2.6 million total customers. Only 82,000 of them pay, but that number was an 8% increase over the third quarter of 2019 alone.
This strategy has a number of potential benefits. First, Cloudflare is getting small but future high-growth companies into its ecosystem early. That gives the software outfit some built-in growth even if its total customer count were to suddenly stall. Second, while small businesses get the software tech they need for free or at a low cost, the strategy allows Cloudflare to test out new products of its own before going after larger deals.
As for those large customers (which Cloudflare defines as having billings of at least $100,000 per year), total count nearly doubled in 2019 and tallied up to 550 at the end of the year. Dollar-based net retention was also 112% in Q4, implying that existing paying customers were spending 12% more than a year ago.
In short, while Cloudflare may get overlooked from the 2019 class of tech IPO stocks, there is a lot of good going on at the cloud computing company. New products are continuously being released, and global spending on the cloud industry is still growing by double digits. Investors who can ride out the ups and downs and scoop up some more shares on the dips should put this stock on their radar.
