Shares of Cloudflare (NYSE: NET) were hammered on Friday despite beating analyst estimates on all fronts with its third-quarter report. The edge computing company is feeling no real pain from the current economic environment. Cloudflare grew revenue by 47% year over year and signed up 159 enterprise customers with annual budgets exceeding $100,000. There are now 1,908 of these large customers on Cloudflare's platform.
While Cloudflare's results were impressive, its long-term outlook was the real story. After reaching $1 billion in annualized revenue in the third quarter, Cloudflare has plans to grow that number to $5 billion over the next five years. To reach that goal, revenue would need to grow at a compound annual rate of about 38%.
This target may seem ambitious, especially considering the state of the economy. Here's why it's doable for this edge computing leader.
Massive market opportunities
Cloudflare got its start protecting websites and servers from attacks. Its platform slides between end users and servers, detecting and absorbing malicious traffic. This requires a global network, which Cloudflare has expanded to over 275 cities in 100 countries over the years.
Cloudflare's greatest asset is optionality. That global network is useful for a whole lot more than keeping customers safe from attacks. Websites can be sped up by caching content close to users; bits of code can be run at the edge; and a full suite of security products can help companies connect employees with applications and data.
Cloudflare's total addressable market was just $32 billion in 2018, consisting of the core security and content distribution services that gave the company its start. TAM has since expanded to $115 billion, and Cloudflare expects it to grow to $135 billion by 2024.
The markets for Cloudflare's core features are still growing; layered on top of that are additional growth opportunities. Cloudflare's Zero Trust platform, which competes with Zscaler and other cloud-first cybersecurity companies, helps employees securely access a company's applications and data. That capability is particular important now that remote work and hybrid work are so prevalent.
Object storage is another big opportunity. Any company making use of cloud computing needs to store arbitrary data somewhere. There are plenty of object storage services available, including on the big cloud platforms like Amazon Web Services. Cloudflare stands out with its pricing. Storage costs are low, and the company doesn't charge for bandwidth at all. AWS, on the other hand, piles on the fees.
Cloudflare is also aiming to become a full-fledged cloud computing platform for developers. It offers Workers, allowing developers to run code close to users, Pages, which hosts static content like webpages, various data products including the D1 database, and messaging hub service Pub/Sub. A full-stack application can be deployed entirely on Cloudflare's platform, albeit with some limitations, potentially eliminating the need for traditional cloud platforms like AWS.
Even if some of these products don't work out quite as well as the company expects, Cloudflare has so many irons in the fire that hitting its growth target looks very doable.
Still an expensive stock
Cloudflare has excellent long-term growth prospects, but the stock is expensive enough that it should give investors pause. Even after taking a beating this year, Cloudflare is valued at roughly $13.5 billion. Based in its 2022 revenue guidance, Cloudflare trades at a price-to-sales ratio of nearly 14.
In this market environment, that's a valuation that's hard to justify. Cloudflare is growing fast, but the company is not yet profitable or free-cash-flow-positive. And while business is still humming along, it's hard to say how durable the company's results will be if global economies enter recession next year.
Cloudflare is a great company, but even the best company bought at too high a price can lead to lackluster results for investors.
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John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool's board of directors. Timothy Green has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Amazon, Cloudflare, and Zscaler. The Motley Fool has a disclosure policy.
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