Cloudflare (NET +1.40%) stock made a remarkable recovery beginning in May, surging 54% since it suffered a sharp sell-off on April 28 following the company's first-quarter 2023 results. Share prices of the internet infrastructure services provider fell 21% in a single day when investors panicked over the news of the company's slowing growth. Cloudflare not only issued tepid guidance for the current quarter, but it also reduced its full-year forecast. And yet, investors seem quick to forget the past, and Cloudflare stock is rallying once again.
Let's see why that may be the case.
NYSE: NET
Key Data Points
AI could become a key growth driver for Cloudflare
Artificial intelligence (AI) was a key theme of Cloudflare's past two earnings conference calls. The company pointed out on its February earnings call that a "leading generative AI company signed a one-year $1 million deal."
It is worth noting that the deal Cloudflare management spoke about in February was with none other than OpenAI. The AI start-up's chatbot -- ChatGPT -- gained terrific traction in a short time, and it needed to quickly shore up its cloud infrastructure to serve the millions of users flocking to the service. OpenAI's existing infrastructure at that time was "insufficient at handling the massive load on their services from legitimate users, as well as keeping fraudulent users from exhausting their resources," according to Cloudflare CEO Matthew Prince.
That's the reason why OpenAI became a paid customer of Cloudflare's services after being a free user for over five years.
Some might argue that a $1 million deal with OpenAI won't move the needle in a significant manner for Cloudflare as it expects to deliver $1.28 billion in revenue this year. But management's comments on the latest earnings conference call indicate that AI is indeed driving meaningful growth for the cloud infrastructure company. While responding to an analyst's query on the May earnings conference call, Cloudflare CEO Matthew Prince pointed out:
AI is something that I think surprised us last quarter in terms of the positive impact, and it continues to surprise us. We've seen the revenue that's coming from AI companies ... have substantial growth north of 20% ... from the large AI companies that use us. And it's not just one or two, but from large to small.
The growing adoption of Cloudflare's offerings by AI companies isn't surprising. After all, accessing generative AI applications such as ChatGPT will require users to connect to the internet, so the connection needs to be fast so that queries can be quickly addressed. Additionally, the network needs to be reliable and secure as well to avoid fraudulent activities. This is where Cloudflare comes into play, as its massive network of servers helps improve the performance, reliability, and security of internet networks.
Given that the company controls a whopping 38% of the global content delivery network market, it is in a solid position to tap the growing adoption of generative AI, a market that's expected to clock 34% annual growth through 2030. More importantly, Cloudflare is already pulling the strings to ensure that it makes the most of this fast-growing opportunity.
The company now offers its Cloudflare One secure access service edge (SASE) platform for generative AI applications. It claims that Cloudflare One for AI will "enable enterprises to safely and securely use the latest generative AI tools without putting intellectual property and customer data at risk." Citing a KPMG survey, Cloudflare management points out that cybersecurity and data privacy are the key points of concern for business executives in the U.S. looking to deploy generative AI.
As a result, Cloudflare could be about to capitalize on a huge growth opportunity as the adoption of generative AI should ideally expand the company's addressable market, which already stands at an impressive $146 billion in 2023. It is worth noting that Cloudflare's addressable market has jumped 4.6 times since it went public in 2019, and the company expects the same to jump to $204 billion by 2026.
The stock is expensive, but it seems reasonable for an AI play
Cloudflare stock currently has a price-to-sales ratio of 21. That's quite high when compared to the S&P 500's sales multiple of 2.5. However, Cloudflare looks like an attractive AI stock when compared to the likes of Nvidia (NVDA 2.94%), which currently sports a sales multiple of 39. More importantly, Cloudflare is expected to deliver handsome growth in the future and is not far behind Nvidia on that front.
| Current FY | Next FY | 2 FY Ahead | |
|---|---|---|---|
| Cloudflare revenue (estimated) | $1.28 billion | $1.67 billion | $2.16 billion |
| Revenue growth (YOY) | 31% | 30% | 29% |
| Nvidia revenue (estimated) | $42.8 billion | $51.6 billion | $63.7 billion |
| Revenue growth (YOY) | 59% | 21% | 23% |
Source: YCharts.YOY = Year over year.
Nvidia is turning out to be a pioneer in AI as the proliferation of this technology is dependent on the company's graphics cards being deployed extensively in the training of AI models and for inferencing as well. That's the reason why Nvidia forecast terrific year-over-year revenue growth of 64% in the current quarter to $11 billion, as companies queue up to buy its chips.
At the same time, the discussion above suggests that even Cloudflare could play an important role in the adoption of AI. Moreover, the company sits on a massive addressable market, as we saw above, and it expects to hit $5 billion in annual revenue by 2027. It won't be surprising to see Cloudflare hit that mark, given the huge addressable revenue opportunity and catalysts such as AI.
If Cloudflare does hit annual revenue of $5 billion after five years and trades at a discounted 15 times sales at that time, its market cap could hit $75 billion. That would be more than triple its current market cap, which is why growth investors looking for a relatively cheaper stock than Nvidia that could take advantage of AI should consider buying Cloudflare before it flies higher.
