Cloudflare's (NET 1.44%) stock has rallied more than 30% this year as the cloud-based content delivery network (CDN) provider impressed investors with its robust growth in a tough macroeconomic environment. It expects its revenue to rise 32% in 2023, compared to 49% growth in 2022, while its adjusted EPS surges 185%.
Investors might be reluctant to chase Cloudflare at these levels given the stock is undeniably pricey at 128 times forward earnings and 15 times this year's sales. However, Cloudflare recently rolled out a new AI platform while securing five new partnerships. Let's see why those six developments could represent green flags for its future.
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1. The launch of Workers AI
Cloudflare's CDN accelerates the delivery of digital content for websites by storing cached copies of the content on "edge" networks that are physically located closer to visitors. Its long-term growth strategy is driven by the idea that companies will need to store more data on these edge networks as they expand into more countries and serve more visitors.
Meanwhile, more companies are integrating AI tools like chatbots into their websites. To support the development of those tools, Cloudflare launched Workers AI, a platform that enables developers to directly build AI applications on its CDN.
Cloudflare CEO Matthew Prince said the company already had all "the infrastructure developers need to build scalable AI-powered applications," so Workers AI would "empower developers to build production-ready AI experiences efficiently and affordably, and in days, instead of what typically takes entire teams weeks or even months."
2. Its Workers AI deal with Meta
Meta Platforms (META 0.43%), the parent company of Facebook, Instagram, and WhatsApp, quickly jumped on that bandwagon by making its Llama 2 open-source large language model (LLM) available to developers on Workers AI. This deal might not directly benefit Meta -- because Llama 2 is an open-source LLM -- but it will give Cloudflare's Worker AI developers a free and easy-to-use LLM that can be utilized to create more AI-powered apps across its edge networks.
3. Powering up its edge networks with Nvidia
AI applications generally run on origin servers instead of edge servers because they require the processing power of high-end GPUs. However, Cloudflare is narrowing that gap by deploying Nvidia's (NVDA 6.18%) GPUs and ethernet switches across its edge networks. It's also using Nvidia's software to accelerate the performance of AI applications -- including LLMs -- across those upgraded edge networks.
In a recent press release, Cloudflare declared that "cloud giants are holding businesses captive." It cited a Forrester Consulting study that found 96% of surveyed companies desired a decentralized "connectivity cloud" -- in which workloads are spread out across edge networks -- as opposed to centralized cloud infrastructure platforms.
4. Laying out the AI railroad tracks with Microsoft
Cloudflare clearly dreams of disrupting the traditional cloud platform market, which is presently dominated by Amazon, Microsoft (MSFT 1.82%), and Alphabet's Google.
However, it still struck a new deal with Microsoft to lay out the "AI railroad tracks of the future so inference tasks can move seamlessly across devices, networks, and clouds." This expanded partnership will break down the barriers between Microsoft's Azure cloud platform and Cloudflare's CDNs while giving them a common language for running AI services.
5. Digging new rivers for Databricks' data lake
Databricks, which is often considered Snowflake's biggest rival, stores data in massive "data lakes" of unstructured data. That approach is a lot messier than Snowflake's data warehouses, which store and organize data in a user-friendly platform.
However, data lakes are generally easier and cheaper to scale than data warehouses as an organization expands. That's why it wasn't surprising when Cloudflare recently expanded its current partnership with Databricks by joining its open-source MLflow project for streamlining the machine learning development cycle. Doing so could make it easier for Databricks users to deploy their data lake AI training models on Cloudflare's CDNs.
6. A developer-oriented partnership with Hugging Face
Last but not least, Cloudflare partnered with Hugging Face, an open platform for AI builders, as its "first serverless GPU preferred partner" for deploying AI models. It claims this partnership will make it easier for developers "to quickly and easily deploy AI globally, without managing infrastructure or paying for unused compute capacity."
Do these green flags justify Cloudflare's premium valuation?
Cloudflare is sending a clear message to the bulls with these six developments: It wants developers to create more AI apps on its edge networks, it's upgrading its CDNs to support said apps, and it believes its decentralized networks could liberate companies from centralized cloud infrastructure platforms like Amazon Web Services (AWS) and Microsoft Azure.
Based on those forward-thinking ideas and its impressive growth rates, I'd say that Cloudflare's stock deserves to trade at a premium valuation. Its upside potential might be limited as long as interest rates stay high, but I believe it's still a great long-term play on the secular growth of the CDN, edge network, and AI markets.
