While shares of other hot internet infrastructure companies like Fastly, Limelight Networks, and Akamai have stumbled recently, Cloudflare (NYSE:NET) continues its torrid advance. The reason? Third quarter 2020 revenue growth accelerated as the company is increasingly being turned to as a trusted partner to secure web traffic during the pandemic.

The case for owning Cloudflare for the long haul is only getting better -- though the stock currently trades for an ultra-high premium.

Someone pictured off screen using a computer. An illustrated lock icon is displayed in the foreground.

Image source: Getty Images.

Q3 2020 by the numbers

Third-quarter revenue growth accelerated to 54% with the top line hitting $114.2 million. Adjusted net loss also narrowed to $5.7 million compared to $18.5 million of losses a year ago. Worry earlier this year that Cloudflare's web delivery and security services might lose steam (like many of its aforementioned peers have) is proving to be a moot point. In its sophomore year as a public company, Cloudflare is having a great 2020.  

Metric

Nine Months Ended
Sept. 30, 2020

Nine Months Ended
Sept. 30, 2019

Change

Revenue

$305.1 million

$203.1 million

50.2%

Adjusted gross profit margin

77.4%

78.0%

(0.6 pp)

Adjusted net income (loss)

($27.7 million)

($53.1 million)

N/A

Free cash flow

($68.6 million)

($72.7 million)

N/A

PP = percentage point. Data source: Cloudflare.  

Perhaps one concerning line item, though, is free cash flow (revenue less cash operating expense and capital expenditures). This software firm's losses are still racking up, though free cash flow this year includes acquisition costs of $13.7 million (presumably related to the purchase of browser isolation endpoint security upstart S2 back in January) and capital expenditures of $46.0 million (up from $31.0 million in capital expenditures the same period in 2019) as the company has rolled out multiple new services in recent months.  

I'm not worried. This is a growth-now, profit-later concern, and Cloudflare is picking up new momentum from all that spending. Outlook for full-year 2020 revenue of $423.0 million (at the midpoint) represents a 47% increase over 2019, and an adjusted operating loss of $37.5 million at the midpoint of guidance would be a big improvement over the $71.2 million loss recorded last year. And though bottom-line red may make some shareholders uncomfortable, bear in mind the company had $1.05 billion in cash and short-term investments and $375 million in debt on the books at the end of September.

Start small, move upmarket later

When the company went public in 2019, I was intrigued by Cloudflare's focus on small businesses and individual developers versus other tech companies that develop new products and immediately start fishing for the biggest catch they can find. Cloudflare will often launch a new service at little to no cost, iron out the wrinkles, and only then start marketing it to larger paying customers.

This strategy has served it well and also yields the company access to small up-and-coming companies that could be larger paying customers later on. Given the uptick in growth in the third quarter, it looks like this focus is working. Out of the many hundreds of thousands of users it has, only 100,000 are paying customers (a new milestone) -- most of them very small. Cloudflare also just signed its first ever $10 million a year client. All told, it makes for a well-diversified base in which no single customer accounts for more than 5% of revenue.  

Cloudflare Workers for building and deploying applications continues to be a hit with management reporting 27,000 developers using the service for the first time in the third quarter, up from 15,000 last year. And other services just made their debut like Cloudflare One for securing network operations and safely delivering web content to users at the network edge.

With its myriad products, this company has a unique opportunity to disrupt the status quo in network security and web content delivery -- attacking services provided by the likes of Amazon's AWS cloud computing money mill.

Given the company is making serious headway, a premium price tag makes sense. Based on the new full-year outlook, that price tag rings up to an incredible 47 times sales. In the short term, a breather is in order for this hot stock. But when it inevitably pulls back, I'm still bullish on Cloudflare's next-gen cybersecurity and internet infrastructure services for the long haul.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis -- even one of our own -- helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.