Cloudflare (NET -1.70%) is having itself a year. Shares of the cloud- and edge-network-based internet infrastructure company are up 64% so far in 2021, building on the massive 345% run it had last year. This is far from a one-off winner from the massive uptick in internet use during the pandemic, and Cloudflare's Q2 2021 earnings update continues to prove that.
This is an "expensive" stock, but if you can stand to patiently wait through the wild ups and downs, this looks like a great business to own for the decade ahead as the cloud reshapes the global economy. Here are three reasons why.
1. Making the internet better for everyone
When Cloudflare made its public debut a couple years ago, it had a unique go-to-market strategy for an enterprise-grade cloud service: Launch new services for free for individual users, then go after bigger paying customers later. It's been incredibly successful.
The company ended Q2 with 126,735 paying customers, an increase of 32% year over year. But Cloudflare has millions of individual users that don't pay a thing. This gives the company a massive base from which to grow as some of those users upgrade to premium products over time.
It isn't just a marketing ploy, though. Cloudflare believes in making a better internet for everyone. Its recently announced Project Pangea embodies that. Project Pangea will provide underserved communities around the world with zero-cost access to the internet. How does that work? Imagine you and your neighbors built a road to a nearby freeway, only to be denied an on-ramp because the cost to built it is too high. Cloudflare will provide the internet on-ramp to these communities shut out of high-speed reliable access to the web.
Image source: Getty Images.
2. Focus on the ultra long-term
Cloudflare's revenue in Q2 increased 53% year over year to over $152 million. Among paying users net-dollar based expansion was 124%, implying existing paying customers spent 24% more than they did last year. Free cash flow was negative $9.8 million, an improvement from the negative $20.2 million in 2020.
While it's good news for shareholders that Cloudflare has nearly hit breakeven, that's not the primary concern right now. Co-founder and CEO Matthew Prince explained on the earnings call that a 20% operating profit margin is still the long-term goal -- but it's a very long-term goal. Prince said his company is "not in a hurry to get there" because it sees no shortage of new product launches it can continue to develop and roll out to its global network.
Long story short, as Cloudflare starts to generate excess cash in the next year, it will aggressively plow that back into the business to promote expansion. Given the huge opportunity ahead (the global cloud industry will likely reach $1 trillion in spending per year by the end of this decade), the bottom line is of secondary importance right now.
3. Cash is a fantastic competitive advantage
Sometimes the best advantage an aggressively growing company like Cloudflare has is a large pile of cash on hand. And that's just what this company has. Of the $1.45 billion in total assets on Cloudflare's balance sheet, $1.03 billion is cash and equivalents, offset by convertible debt of just $401 million. This is an incredibly efficient business with plenty of optionality as it expands in the internet and cloud infrastructure space.
For full-year 2021, management now expects revenue to be at least $629 million (compared to previous guidance for as much as $616 million), representing growth of at least 46% from 2020. Shares trade for some 36 times expected full-year sales to enterprise value (market cap plus debt, minus cash). It's quite the premium price, but Cloudflare has thus far demonstrated its ability to steadily grow at a pace at or over 50% -- even when lapping the pandemic lockdown bump it got last year. This looks like a top cloud infrastructure stock to keep buying for the long-haul.
