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With a revived sales operation and excitement around its signature product, Workers AI, cybersecurity company Cloudflare NET stock is up 50% since the start of 2024, even with a 27% drop since the middle of February. For investors, the question is whether to jump in or wait for more attractive levels. “There was a general broad-based market rally that lifted many software stocks, and Cloudflare certainly benefitted,” says Morningstar equity analyst Malik Ahmed Khan. “The more Cloudflare-specific element has been investor excitement around Workers and how more developers are leveraging its platform to build out AI applications.”
Why Has Cloudflare Stock Rallied?
The rally over the past year marks a significant change of fortune for Cloudflare. From 2020 through 2021, the stock staged a rose nearly 1,000%, topping out just shy of $200 per share. It then collapsed toward $40 per share in mid-2022. After a roller coast push higher, Cloudflare took off in the third quarter of 2024, surging from roughly $80.00 per share to a high of $176.50 in February, with help from strong fourth-quarter earnings. However, it was caught in the broad selloff in technology stocks and has since fallen back to around $120 per share.
Khan says the 2022 selloff came as the company suffered a dip in productivity from an underachieving sales effort, which took its guidance for fiscal 2023 sales down by $54 million. “Essentially, the company’s sales reps were not as productive as the firm would’ve liked,” he says. “This dip in sales productivity was magnified by a general elongation of the sales cycles, which impacted not only Cloudflare but other software companies.” However, Khan believes this selloff was fundamentally unwarranted. “We thought the selloff was overly punitive, and our confidence in the company was proved correct, as it replaced underperforming sales folks with higher-performing ones, and sales eventually rebounded.”
Investors who bought in the dip were rewarded in 2024, when the stock took off as part of a marketwide rally, combined with the excitement for Workers AI. “Workers can be helpful in serving inference demand while keeping costs low due to the price competitiveness Cloudflare offers versus public cloud vendors,” Khan explains. Another catalyst was improving fundamentals. “The firm’s topline growth remains solid, while its profitability has shown clear signs of improvement,” he says. Additionally, he thinks Cloudflare is on track to turn a profit: “We expect the firm to hit GAAP profitability starting 2027, with the firm having been non-GAAP profitable since 2022.”
Cloudflare’s Outlook
Workers AI is a critical aspect of Cloudflare’s outlook. “We continue to expect Workers to be a bigger part of the Cloudflare story going forward, which should support growth rates beyond security and content delivery,” Khan says. He believes Workers AI and its ability to leverage its distributed infrastructure could be “highly lucrative … we expect this business to be value/margin-accretive over the long term, especially as genAI demand continues to ramp.” Khan also cautions investors that there remains “substantial execution risk … [Workers AI is] an exciting product, but the firm’s execution needs to be stellar for it to continue to gain traction.”
Cloudflare Valuation
As Cloudflare stock pushed higher this year, Khan was skeptical of the extent of the gains: “We didn’t think the rally was justified.” With the stock now trading at roughly $120 per share, it is within range of being fairly valued. It would take a decline to $83 before Cloudflare entered 4-star territory and could be considered undervalued. “Investors should keep a close eye on Cloudflare,” Khan says. “The stock can be quite volatile, and we have seen it trade down quite sharply with other high-growth tech stocks. If macro pressures continue to weigh on the stock, there is a chance that investors may get a buying opportunity in the near future.”
The following are highlights of Khan’s current outlook for Cloudflare and its stock. The full report and more of his coverage are available here.
Economic Moat
We believe Cloudflare merits a narrow moat rating, owing primarily to strong switching costs and network effects associated with its product offerings and core business. When analyzing Cloudflare, we find ourselves looking at two different companies. The first one is Cloudflare of today: a security-focused content delivery network that channels more than 10% of global internet traffic. The second one is what we think Cloudflare is setting itself up to become: a player in the public cloud space and a beneficiary of the edge computing megatrend. With an increasingly large target addressable market, expanding upselling abilities, and a sticky product portfolio, we believe Cloudflare is more than likely to generate excess returns over the next 10 years and, therefore, merits a narrow economic moat.
Find more of Khan’s analysis of Cloudflare’s economic moat here.
Fair Value and Profit Drivers
Our fair value estimate for Cloudflare is $104 per share, implying a 2024 enterprise/sales multiple of 17 times. We forecast Cloudflare’s revenue growing at a 27% compound annual growth rate over the next five years with secular tailwinds behind its back. We view Cloudflare’s future growth as a result of two key drivers. First, the firm’s security business is primed for growth as it lands bigger clients and upsells them more modules. Further, this vertical is poised for growth as a result of a general increase in cybersecurity spend as businesses deal with a more complex web of cybersecurity threats than before. Second, the firm’s investment in the edge computing platform provides it with another driver of top-line growth. As edge computing becomes a larger part of the overall technology ecosystem, we believe Cloudflare will continue to drive meaningful margin and top-line expansion.
Find more of Khan’s analysis of Cloudflare’s fair value estimate here.
Risk and Uncertainty
We assign Cloudflare a Very High Uncertainty Rating due to the nascent nature of its competitive, high-growth markets. In its core security business, Cloudflare faces competition from other cloud-first security businesses such as ZScaler. At the same time, Akamai, a CDN pioneer, has invested heavily in building up its security portfolio. In the edge computing space, it is hard to eschew the David and Goliath comparisons, as the company competes with Microsoft, Amazon, and Google.
Find more of Khan’s analysis of Cloudflare’s risk and uncertainty here.
NET Bulls Say
Cloudflare has strong tailwinds as edge computing becomes more prevalent.Cloudflare’s security business is set to grow fast due to the overall security spend of enterprises going up as they deal with more complex issues.Cloudflare has a long runway for growth in terms of enterprise penetration in its security business.
NET Bears Say
Cloudflare is in direct competition with well-established, far larger incumbents like Amazon, Microsoft, and Google in the edge computing space.Cloudflare is unprofitable on a GAAP profitability and may not achieve it for a few more years.We believe that Matthew Prince, the firm’s founder and CEO, is a hugely influential person in the firm. If he were to leave or retire, Cloudflare’s future strategy and execution could suffer.
The author or authors do not own shares in any securities mentioned in this article. Find out about Morningstar’s editorial policies.
