I believe in Cloudflare and sleep very well at night knowing Matthew Prince has stakeholders best interests, I cannot say the same for other businesses. I am comfortable + I sleep. In this report I will talk about the earnings call, nibble some 10-Q data, and give my thoughts on where we could be headed. As you all know, I had shaved it from a 62% position to roughly 40% given valuation and I had a feeling growth would sell off. After doing this for years as an analyst, you start to develop a sense for markets, patterns, news flow, and I would not considering it market timing, I just listen to ebbs and flows of the market using my indicators. Not luck, just strategy. I have the time, resources, and experience to take my time and think about my strategy. I think my returns and honesty have proved that over time.
Let me start this report by noting that I will continue to stay long this company and it will be my largest position, Fastly is troubled, management is awful, and at the end of the day I view them as no threat to Cloudflare and are just an overvalued usage based CDN. I have warned people to stay away from that company, and invest capital elsewhere. No value in them, and if people read Prince's blog posts, it is not always about speed and the "compute@edge" story at this point is just dead PR news. Market does not currently care and maybe it never will. Maybe I am wrong.
Initial Press Release:
Great report, beat all levels of my expectations. Beating revenue estimates by 5.41%, in-line with their average beats. Revenue came in at $138.1m, up 51% YoY (unreal), DBNR sitting at a sweet 123%, which is an increase of 600bps YoY. Their large customer growth is growing nicely, adding 120 large customers in the Q that now account for great than 50% of revenue.
Guidance, was indeed raised for FY (I am mostly focused on that, Q2Q is dumb sometimes, the rest is gibberish to me). Total revenue for FY21 is now $612-616, which is an increase (at the midpoint) of 42%. I still believe this is garbage, and I see $646m representing a 50% increase YoY. I suspect they will beat and raise each Q in order to sustain a premium (very premium) valuation. Any mishaps, bye bye share price!
Coming out of COVID they should THRIVE in this environment, I do not understand why sales would slow as customers spend and figure out their digital transformation process. Prince notes they are firing on all cylinders, I love his energy. "No slowing down". He gets me pumped for what is ahead.
I enjoy investing in high quality businesses with focused management. Cloudflare is that business.
Thoughts on the Call:
I listened to the call in the car, then re-read the transcript before I went to bed at 1am. I wish I had as much energy as Prince, and the way he describes the business, products, and overall broader market picture he is seeing is unmatched. Here are some snippets in bullet point form I think are valuable from the call noted by Prince:
Large customer count +70% YoY, revenue for large customers now over 50% of total revenue
DBNR was 123%, up 400bps sequentially and +600bps YoY
Little of their revenue is usage based (shots fired at Fastly), and since they are not dependent on this, they see no indication that as we come out of COVID, things are slowing down
Entered strategic partnerships with leading SD-WAN appliance vendors, Data center operators, data vendors, observability companies, dev ecosystem support services and even the leading graphics process company (NVDA)
Bot management launched two years ago, revenue from this product growing north of 400% compounding annually
The ability to build products faster and better = leverage on the overall Cloudflare platform
Deals? Yes, we have some nice deals and you can see the strong enterprise wins.
Fortune 500 retailer: three-year $1.2m contract for Cloudflares platform. This company preferred the well-integrated approach in performance and security over "cobbling together multiple point vendors, or using the Frankenstein like solutions other companies have tried to create through M&A".
Fortune 500 financial services firm: turned to NET when they were under a cyber-attack. Adopted the Magic Transit Solution to protect entire internet, $600k contract three-years
Another F500 financial services firm chose them over legacy providers, signed a three-year $1.9m contract.
Leading SaaS eCommerce platform chose NET, signed a $3.6m 38-month contract. This is a major win because now a majority of leading eCommerce platforms are powered by Cloudflare (another lovely dig at Fastly).
Continuing with the call thoughts. Prince laid out his worries on what he sees ahead:
Security. Dramatic uptick in volume and sophistication of cyberattacks, not only targeting their customers, but the company directly.
Team and culture, transition to what is next after remote work environment. He worries there will be an upheaval across industries as employees reassess their future outlook
Regulatory risk. Tech businesses from do no wrong to, to do no right. Regulation is on a global basis, not just the US. Given almost 50% of revenue for Cloudflare is ex-US, Prince has to be focused on the complicated regulations globally.
Cloudflare as a business is constantly under attack, given their industry. What do they do with these attacks? They learn from them and build out their Zero Trust to be even stronger. Talk about learning from mistakes, or simply striving to be better at what you do. Ending the Q, Cloudflare has 4.1m total customers (free and paid) up 46% YoY. The single largest cohort of customers that are growing the fastest are the $1m+ customers. The bread and butter.
RPO (Remaining Performance Obligation) was strong, coming in at $439m, increasing 14% QoQ and 88% YoY. Their RPO is growing faster than their quarterly top-line, which means we have a lot of highly sustained double digit growth for years to come. Sandbagged. Revenue.
88% of their customers are now using 4+ products, they are becoming a sticky (dare I say ecosystem) for their end user. China headwind switching to JD.com is a nothing-burger for me, I dont care and I dont know why the analyst even asked that question when it was highlighted in the last report. These guys are totally useless sometimes. Their guide includes China headwinds, and they noted it in the last call. Wasted time on that question.
The Q&A portion of this earnings call is only good when Prince speaks, the analysts do not ask very good questions. The only good Q I really saw is this, I will just screenshot it for you all:
Yes, it is a win for Nvidia as Cloudflare is now a customer. But as an analyst you have to look deeper, this is a win for Cloudflare as they utilize the highest end GPUs for AI at the edge and this could potentially drive increased enterprise adoption. They are really going after compute platforms here, and I am riding this wave till the end. Cloudflare has already used their GPUs internally, I think this only drives name brand and its like an indirect affect on Cloudflares business that could result in positive catalysts in general.
Cloudflare is simply on another level, and not a competitor to any of these. Maybe they get lumped together, but I fully disagree with it.
This had to be one the most clear calls I have listened to and read from them, their vision, determination, and grit is there. I will continue to stay long shares and hopefully get an opportunity to add much cheaper than today, it is still not cheap all.
This is my favorite part. 10K nuggies. Look, investing is fun. We get to learn about the coolest businesses on this planet driving the internet and digital transformation. I will take screenshots and dissect with my thoughts in the nugget section.
Gross margins have stayed relatively flat, with loss from operations improving sightly YoY. Free Cash Flow margin has improve significantly YoY, along with Net Cash used in Operating, Investing, and Financing activities. Paying customers is what catches my eye, jumping 33.6% on a YoY basis. There is still a lot of potential monetization left at this company, and sometimes I have no idea how to model growth.
So, United States is becoming a larger % of total revenue YoY which makes sense with all the domestic large contracts they are winning. The drop off in Asia Pacific YoY does not worry me as I believe it is due to thee transition of China Vendor to JD.com, they mention this headwind (that is included in guidance) in the last 2 calls. I see no issue here.
Above are the percentage of revenue data, Cloudflare is spending 51% of their revenue on S&M, which is fine for now as they spend for continue growth (which it is showing).
One thing I like to run dow in SEC filings is something like this:
What drove revenue? --> Primarily due to new paying customers, increasing 34% YoY
What drove cost of revenue? --> Increasing in expenses related to operating in co-location facilities and network and bandwidth costs for Cloudflares infrastructure platform (and expanded customer base)
What drove S&M? --> Employee-related costs, 45% increase in headcount in sales & marketing organization, and SBC ($2.5m)
What drove R&D --> Employee related costs 36% increase in headcount in R&D + $2.6m in SBC
What drove G&A? --> More employee related costs, 39%+ in headcount in the G&A
Now we can answer each of these, and they are good to know (and study) on a YoY basis so you can see how they are operating and executing.
Fiducia Final Thoughts:
I mean in general the report was way better than I was expecting. It has taken me a few days to write this because I am letting it marinate, Matthew Prince knows what he is doing and he knows what people want to hear. He even cited his own risks he sees after such a great Q. The consistent learning the business does from cybersecurity attacks speaks to me, they are open about it and when something goes wrong they are right there to admit and fix it. Enterprise customers are growing rapidly and they are securing (what I think) are some pretty large names who they will continue to sell products to in order to keep the DBNR where it is.
Yes, this is a very richly valued company I am fully aware of that. I am not a net buyer here (ha no pun intended), but I could still see them rallying some more with the broader market. Personally I would have another shaving price around $95-100 as I believe valuation would be too rich for that weighting in my portfolio which is around 40% currently. As we enter a frothy market that continues to rally, I am carefully considering my options as a PM in how to delegate the proceeds when I do decide to shave more (if given the opportunity, perfectly content holding here).
There is a huge difference between a great business, and a great business that is priced to essential perfection. Cloudflare feels like the latter, but there are still buyers showing up. With premium management, and premium execution, I think the share price reflects that in the strength of how they hold up against others.
I do hope people understand they are not competitors with Fastly, they are in a completely different ball game here. Biggest competitors I would view are Azure and AWS and even they are not really killing it in Cloudflares space.
I highly recommend reading the earnings call, especially the Q&A section. There are some very well-thought sentences in there from Prince.
THIS COMPANY IS FIRING ON ALL CYLINDERS, ITS LIKE A V12 JUST REVVING UP.
I feel I dont even need to write about this company anymore unless something bad happens.