Cloudflare (NET +2.13%) isn't a household name today, and it probably won't ever be one. But the services it provides are becoming more relevant every day. Cloudflare's mission is to build a better internet, and it's doing just that. With tailwinds of software applications moving to the cloud, this behind-the-scenes specialist could become a multibagger in your portfolio over the long run.
Let's look at three reasons why.
1. It has tremendous optionality in a massive market
Companies are transitioning from legacy on-premise hardware solutions (servers in their own data centers) to using software-as-a-service applications. As companies make this leap, they find that the Band-Aid solutions they've put in their own data centers to make their applications run faster are no longer adequate. Enter Cloudflare.
Image source: Getty Images.
Organizations can use its integrated global platform (outlined below) to protect their websites from hackers, ensure prospective customers around the world can access content quickly, and help management sleep soundly with its 100% uptime guarantee.
Cloudflare's products include cloud applications for security, performance, and reliability. Image source: Cloudflare investor presentation.
The platform's capabilities are impressive. One customer that demonstrates this is Shopify, which powers the e-commerce websites of more than 1 million merchants globally. The massive surge of online shoppers during Black Friday is one of the key reasons Shopify turned to Cloudflare. Now that it's plugged into Cloudflare's network of data centers in 200 cities around the world, 99% of shoppers can get access to the million-plus e-commerce stores running on Shopify in less than 100 milliseconds.
The addressable market for Cloudflare's cloud services is expected to reach $47 billion by 2024. With trailing-12-month revenue of $389 million, the global cloud platform has captured less than 1% of its potential opportunity, leaving plenty of room for growth.
2. Customers love the product
Paying customers have grown at a 22% compound annual growth rate (CAGR) over the last two years to reach over 100,000. But top-line revenue is growing even faster, showing that customers are expanding their usage. Dollar-based net retention has been a solid 115% or more for the last 10 quarters. But large customers (paying more than $100,000 annually) are growing faster than average too, and contributing significantly to the top line. These customers grew at a 68% CAGR for the last two years to reach 736, and now account for almost half of the top line. Add all this up and you get a 54% year-over-year revenue growth rate in Q3 2020, with revenue totaling $114 million for the quarter.
But the best may be yet to come. Remaining performance obligations (the value of services under contract not yet delivered) grew sequentially by 25% to $342 million, an 81% year-over-year increase. Cloudflare won its first $10 million-in-revenue customer this quarter, but still only has 16% of the Fortune 1,000 as paid customers. It has a strong 48% of its revenue from outside the U.S., showing that its services are valued no matter where customers are located.
But its solid track record of growth and massive market are just two reasons to buy this stock. There's one more, and it may be the best reason of all.
3. Its services are only getting better
Cloudflare has 100,000 paying customers, but it hosts more than 3.2 million customers with over 26 million properties. This is because it offers a freemium product to allow potential customers to try a scaled-down version of its products. This is not only a great way to capture new customers, but it also makes Cloudflare's products better. With its network getting pummeled every day by more than 76 billion cyberattacks, any new threat is an opportunity to improve security for all customers.
In addition to the daily learning that happens in the wild world of the internet, the company's strong research and development team is hard at work. The company spends almost a third of its revenue supporting this team that's developing complementary products and enhancing existing ones. With its cloud-based subscription model, the company is able to gain real-world insights into what features customers are using and where they might get hung up. This real-world knowledge further informs its development efforts.
I love that this cloud-based platform will only get better from here.
The bottom line for investors
No investment is without risk, but this stock may be a bigger risk/reward trade-off than many investors can stomach. With the stock's tremendous run this year, its price-to-sales ratio is a nosebleed 63, even higher than Shopify's 52. Competition is fierce. It not only competes with the big three cloud-service providers (Amazon's AWS, Microsoft's Azure, and Alphabet's Google Cloud), it competes with cloud security companies like Zscaler and content delivery network providers such as Fastly.
But the market for cloud services is growing and there's plenty of opportunity for everyone. Look for this founder-led tech company to continue to win customers and grow over the long term because of its ever-improving platform. Patient investors would do well to start a small position today and add over time.
