Since the company released its final quarterly update of 2020, Cloudflare (NET 2.21%) stock has been trading for an incredible 60 times trailing 12-month revenue -- full-year revenue was $431 million, up 51% from 2019, and the current market cap is at $26.5 billion. That's enough of a premium to give even an investor comfortable with sky-high valuations at least a brief pause before buying.
However, this stock remains on my watch list in spite of such an absurd price tag. Cloudflare stock could be headed for a pullback after the last report, but the business itself is positioned for explosive growth over the next decade. Here are three reasons why the valuation doesn't tell the whole story.
Image source: Getty Images.
1. Follow the developers
Cloudflare first intrigued me with its go-to-market strategy shortly after its IPO in 2019. The company offers its content delivery network (or CDN, an internet infrastructure that manages the movement of data) services for free, with users paying for upgrades and premium features. More than 50,000 new developers wrote and deployed their first applications using Cloudflare's global edge computing network in Q4 alone, bringing total user count up to a staggering 3.5 million.
CEO Matthew Prince explained on the earnings call that web developers are flocking to Cloudflare's platform because of its ease of use and because zero-trust security architecture is built in. Most of the 3.5 million users of Cloudflare don't pay anything, but they're still generating lots of new business by attracting more attention to the company's services. Cloudflare ended 2020 with 111,183 paying customers (a 32% year-over-year increase), though only 828 large customers (up 57% year-over-year) that pay over $100,000 a year. Those deals include one with Apple (AAPL +0.62%) to create a new web browsing standard to keep your internet service provider from knowing which websites you visit.
828 large customers is still a small number in the grand scheme of things. However, as Prince put it on the earnings call, "developers are the future of IT." When looking for emerging tech trends to invest in, look for the new tools showing up in their toolkits. Cloudflare is quickly becoming a staple in this department, and will help the company continue to add new businesses to its customer list for a long time to come.
2. Mobility is a modern staple, but it's not tied to a phone anymore
Cloudflare is a CDN, which means it competes with the likes of legacy CDN and industry leader Akamai (AKAM +1.34%). But Cloudflare is so much more than a basic internet infrastructure company. Its suite of services covers all sorts of things, from web page creation to cybersecurity to network management.
It sounds simple enough, but the breadth and power of Cloudflare's platform is a serious disruptor of the current internet status quo. In highlighting various customer wins over the last quarter, Prince said one Fortune 500 financial institution inked a three-year, $1.6 million deal to replace the services it was previously getting from a telecom provider. That's right, Cloudflare is replacing telecom spending -- a staple these days given the digital world we live in. But communications tied to a phone, even a smart one, is so 2010s. This is the 2020s, baby, and cloud communications untethered from phone companies is where it's at.
As more organizations seek out solutions to new challenges accelerated by the pandemic, Cloudflare's platform is poised to continue its momentum. And in the new cloud-based-everything industry that's emerging (valued at $1 trillion a year globally by some estimates), there's no shortage of opportunity for Cloudflare. Management's initial forecast for full-year 2021 is for revenue to increase at least another 37% from 2020 levels. Oh, and don't forget the $1.03 billion in cash and equivalents that the company could decide to deploy in the years ahead.
3. A unified approach to security, computing, and user experience
Speaking of putting cash to work, Cloudflare recently announced a very small acquisition of web browser security start-up S2 Systems. But the lion's share of what Cloudflare has accomplished to-date has been in-house innovation. According to Prince, a reason the company's sales team has been so successful is that the research and development teams "keep delivering more products and features our customers need." Dozens of new products and capabilities were added to the platform in 2020.
The result of all that innovation is a unified approach to building, delivering, and securing content and applications on the internet, one that should help Cloudflare continue to pick up new customers and grow with the millions of users it already has. To wit, net dollar-based expansion accelerated to 119% in Q4 (up from 116% in Q3), implying the average existing customer spent 19% more with Cloudflare than a year ago. As more capabilities are added, this expansion of existing relationships should continue for the foreseeable future.
Premium aside, this is one of the most promising internet infrastructure companies for the coming decade. Cloudflare's innovation is yielding lots of new features, it's flush with cash, and it has a highly disruptive product that's helping it scoop up large chunks of market share in the cloud and edge computing race.
That's not to say Cloudflare is going to just continue rising indefinitely. On the contrary, I expect a hiccup could be right around the corner as the company starts to lap the initial effects of the pandemic -- Cloudflare saw a big surge in new users last year, setting a high bar to be cleared in 2021. Nevertheless, this is quickly becoming a powerful player in the cloud and edge computing industry. At the very least, this stock deserves to be on investors' radar.
