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Here's Why Cloudflare Is a Stock You Should Pay Attention To

By Matthew Frankel, CFP® - Updated Jun 25, 2021 at 4:27PM

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This cloud-based cybersecurity company should be on your radar, and here's why.

When it comes to cybersecurity, there is clearly an opportunity for investors as the industry evolves. In this Fool Live video clip, recorded on May 28, contributor Matt Frankel, CFP, and Fool analyst Tim Beyers discuss why cloud-based security provider Cloudflare (NET -1.76%) could be one of the best ways to play the space.

Matt Frankel: Cloudflare is a security company for the next 10 years. Their cloud-based model -- they use what's called edge computing. I'm more familiar with a company called Fastly (FSLY 1.77%) that's more of an edge computing play. But Cloudflare uses edge computing to protect against cybersecurity breaches. They say their network handles about 650 million Internet queries daily.

The whole premise of edge computing is to bring the access points closer to the end users. Cloudflare has access points at over 200 cities throughout the world, and they claim that 99% of Internet users are close enough that they can access the network within 0.1 seconds or less. That's a pretty impressive network.

They offer a freemium model. They have free tier of service that they offer to get people in the door, which has proven to be a very effective customer-acquisition strategy. Their professional services are very affordable, actually. Tthey start at $20 a month, for business plans they start at $200, which, compared to some of these other cybersecurity plays, is pretty low.

It's been a very effective model. Their revenue has grown at over a 50% annualized rate since 2016. That's a pretty impressive rate to keep up for that long. The net dollar retention, meaning that they are upselling their customers, has been in the 115% to 120% range consistently. It was 119% at the end of last year. They're doing a great job. It's kind of the land-and-expand business model. They are getting people in the door with their free and lower-cost subscriptions, doing a great job of upselling them. So just to tell you what that means, 119% means that the average customer who was spending $100 last year is now spending $119. It's the best way I can describe that metric.

The CEO is the co-founder of the business, still has a pretty sizable stake, around 12%, and this jumps ahead to one of Anand's questions down the list.

But one of the most impressive statistics I saw was that they said in 2018, their addressable market was about $32 billion in size. They expect the cybersecurity market that they can address directly to grow to $100 billion by 2024. That was probably the most impressive statistic is just how quickly this market is growing and how many winners there could be out of this list.

Tim, what'd I miss?

Tim Beyers: You covered a lot of it. By the way, I just have to say, I don't know when you moved to Winterfell, Matt, but look at that behind you. That's amazing. That's full-on Game of Thrones back there. I love that.

Frankel: That's the hammer of Thor. This is not my house, by the way.

Beyers: I love it.

Frankel: I'm in a co-working space. Normally I'm in front of the Warrior mindset sign that's over there.

Beyers: Nice.

Anand Chokkavelu: Got it.

Beyers: Nice. No, it just screamed Winterfell to me there for a second.

But anyway, I think you covered most of it. The right way to think about Cloudflare is they put you on their network. Essentially what they do, they've done, with a simple line of code they say, look, when somebody wants to look you up, they're going to look you up through us. We're going to give you a DNS identifier, a domain name identifier, and so if somebody wants to get to you, they come through us, they come through our network, and we administer that.

What that does, is the most common attack on any type of website is what's called distributed denial of service attack. Basically you take a whole bunch of zombie computers, and all they're doing is they're essentially doing the computer equivalent of throwing themselves against the walls of the network until the walls break. Just constant requests, just boom, boom, boom, hit it, hit it, hit it, hit it. And the Cloudflare network is so big and so used to this that they just deflect these attacks, they swat them away. When you're behind that wall and that wall doesn't come down, you're protected. That's the genesis of the Cloudflare model, and these points of presence, the content delivery network upon which this was built, is a by-product but just a better way to do security from the Cloudflare point of view.

Where it's similar to Fastly is, Fastly does some security too. It's not the same type of thing. Where this is different is what Fastly is doing is what tends to be called a web application firewall, meaning something comes in, a company looks you up, an IP address is coming in, we look at that IP address and say, "Is that IP address OK?" If it's not and if the traffic coming through feels suspicious, we shut the pipe. That's it, and no more. We do that entirely through through the network.

Cloudflare can do that too. There's some other intelligence Fastly puts into its environment. But both of these ideas are good ideas. That's not the only way to do cloud security, but it's a way to do cloud security, and Cloudflare's really good at it.

So yeah, I think you got it, Matt. The basic idea of, hey, you know what? Don't go on the Internet on your own. Get a bodyguard. That's us. That's Cloudflare.

Anand Chokkavelu, CFA owns shares of Fastly. Matthew Frankel, CFP has the following options: short July 2021 $70 puts on Fastly. Tim Beyers owns shares of Fastly. The Motley Fool owns shares of and recommends Cloudflare, Inc. and Fastly. The Motley Fool has a disclosure policy.

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Stocks Mentioned

Cloudflare, Inc. Stock Quote
Cloudflare, Inc.
$77.23 (-1.76%) $-1.38
Fastly, Inc. Stock Quote
Fastly, Inc.
$12.05 (1.77%) $0.21

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