Content delivery network provider Cloudflare (NET 1.44%) is still growing at a brisk pace, but the company has experienced a meaningful slowdown this year. Part of the problem is the economy. As economic uncertainty ramps up, businesses big and small are becoming increasingly cautious with their spending.
Another issue is Cloudflare's sales operation. As the company's portfolio of products and services has expanded, the pitch to potential customers has become muddled. Cloudflare offers a huge number of products, including content delivery services, Zero Trust security, and a full-fledged application development platform. Combine that complexity with a tougher sales environment in general, and you have a recipe for slowing growth.
Cloudflare's revenue grew by 37% year over year in the first quarter of 2023, and the company guided for full-year growth of just 31%. The sales team is being revamped, but that effort will take time to pay off. In the near term, Cloudflare needs to find other ways to accelerate growth.
Making migrations easy
In the world of enterprise software, high switching costs are a powerful competitive advantage. Lower prices, or even vastly superior products, often aren't enough to convince businesses to switch providers. Ripping out a piece of mission-critical software is a disruptive process that carries a lot of risk, even if there are plenty of benefits once the process is complete.
Content delivery networks aren't all that difficult to swap out: It's often just a matter of pointing domain names to a different provider. But companies that use CDNs like Cloudflare, Fastly, or Akamai are likely using a slew of other products, services, and features that tightly integrate with the CDN. For Zero Trust security, the stakes are higher. Any downtime means employees may not be able to access critical resources securely.
Cloudflare is aiming to make the process of migrating from a competitor to its own services much easier. In addition to new migration guides and resources for businesses that want to undertake the process on their own, Cloudflare now has a dedicated Professional Services team that will work directly with customers and create customized migration plans that minimize risk and disruption.
While Cloudflare has around 168,000 paying customers, more than 60% of its revenue comes from the 2,156 customers that spend more than $100,000 annually. Big enterprises are the key to Cloudflare's long-term growth, and the challenge now is to convince those enterprises to switch from other providers. Only 30% of Fortune 1,000 companies are paying Cloudflare customers, leaving plenty of opportunity to expand the enterprise customer base.
Cloudflare is betting that there are a significant number of enterprises effectively stuck with their current CDN providers. By reducing the switching costs by guiding those customers through the migration process, Cloudflare could win additional enterprise customers and reaccelerate its growth.
A pricey stock
Cloudflare is valued at around $21 billion, or roughly 16 times its revenue guidance for 2023. That's a high price to pay, especially considering that its revenue growth rate is currently deteriorating.
Cloudflare's total addressable market is expected to top $200 billion by 2026, and it could expand further as the company launches new products. Paying a premium for Cloudflare stock makes sense given this growth opportunity, but it may take a while for the company's results to catch up with its valuation. The new push to poach enterprise customers could accelerate that process.
