Cloudflare, here's what we were missing!

[SaulR80683]

Since I was the one who was wondering what we were missing, I decided to go ahead and summarize the various ideas people had to explain what it was that explained the big rise. These are all abbreviations of what the authors wrote, with some slight paraphrasing. I really appreciate everyone who contributed.

There were also a few posts saying essentially that “You ought to get out!” but that’s not what I was looking for, I was looking for “Why is the stock continuing to rise?”

Well, here’s my summary of what you all wrote. That was true crowd-sourcing!
Thanks to you all!
Saul

One, the announcement of Cloudflare R2 Storage. AWS charges an egress fee every time a company takes data out to analyze it or whatever (That serves to lock the data in once it’s there). That will be free on Cloudflare! This could save companies a huge amount of money. Because there are no transfer fees, developers can change how applications are designed. Cloudflare has other tools in this update that will improve performance while reducing fees.

One A, The reason is in plain sight. I believe it’s because of the new product offering: R2 public cloud data storage. The market for public cloud is massive. It’s like Cloudflare just started a new company with minimal cost. All new services run on existing servers.

R2 is to disrupt AWS. The bandwidth cost has declined substantially over the past 2 decades but AWS kept most of the saving to itself and has a fat margin. Cloudflare R2 storage is simply passing the saving on to customers. So what AWS is going to do?

If Cloudflare succeeds taking some share from AWS, it can take share from Google Cloud, Microsoft Azure too. Also the market keeps expanding and there will be new companies constantly being created.
Another point to think about: customers like having choices. They don’t like being locked into a quasi-monopoly. Some people will switch for the sake of switcing/dislike of big AWS.

With additional revenue from R2 storage, I see Cloudflare revenue starting to accelerate in the next few quarters. The market is forward looking. The stock didn’t go up 60% in month just for the emotions.

“The global Content Delivery Network (CDN) market size is expected to grow from USD 14.4 billion in 2020 to USD 27.9 billion in 2025, at a Compound Annual Growth Rate (CAGR) of 14.1%” - marketsandmarkets

“Cloudflare has taken the CDN model, added a wide range of enterprise Network as a Service (NaaS) features, and demonstrated it can scale.” - Forbes

Two, at the edge, their main competitor was Fastly, which is floundering.

Three, Cloudflare is investing in innovation and putting out dozens of new enhancements every month. It may not yet be accelerating growth, but it is potential.

Four, What we may be seeing is the collective confidence that Cloudflare is going to massively succeed.

Five, Cloudflare is a content delivery network (CDN). It places geographically distributed servers closer to your area that speed up the digital information transmission. How is this beneficial: speed, reliability (fewer outages), cost. Last rise in stock started on day that Facebook had a six hour outage.

Six, countries are putting up firewalls around their population (China, etc). Cloudflare has the solution for that (Jurisdictional Restrictions)

Seven, Cloudflare is getting the benefit of its CEO articulating the vision of becoming the 4th hyperscalar / cloud / IaaS company (after AWS, Azure and Google Cloud), and the delivery of R2 as first step to match that vision.

Eight, Cloudfares dominance in regards to reverse proxy…
“A reverse proxy is a layer between a web server and the rest of the Internet. It provides security and better performance. Your computer doesn’t have to connect to a single server”

Cloudflare currently does 18.4% of the entire internet in regards to reverse proxy. Second place is Fastly with ……1.7%, showing Cloudflare has an enormous lead. But the huge majority of sites, 77.2%, still don’t use a reverse proxy server service. Mind blowing!

Nine, The current move of Cloudflare in taking on Public Cloud players was HUGELY appreciated by the market. I guess the sentiment guesses that they will be a serious player in public cloud in the future. I also think that Cloudflare’s CEO is one of the best story tellers and sales-man CEOs around.

Ten, “The Edge” is an entire new layer/frontier of the Internet, with an essentially infinite TAM, and everyone else is flubbing their attempted conquests of it; Cloudflare is the only player who is executing well.

Usually you have the story first, and numbers follow if all goes well…in this case, we’ve had great numbers to this point, but the market is responding at this point to the emerging story. (Including that Cloudflare could be a AWS-killer).

Eleven, With Cloudflare Workers and a bunch of other services that Cloudflare is busy rolling out, there’s starting to be a strong economic incentive to move certain workloads to its platform. Data gravity is real; “where your data lives” is usually with the provider that starts to see a lot of your other workloads as well.

I work in a different area of Tech and “data is gravity” is a thing. If customers start migrating data to Cloudflare, then Cloudflare becomes a true competitor to Azure, AWS and GCP. The TAM becomes a lot larger and thus the opportunity for growth goes with it. I think that it is this speculation that is driving the stock price. Their is a pent up dissatisfaction with the public cloud vendors and Cloudflare is tapping into it.

[LifeOfDreamer]

Agree with a lot of those points, but look at R2 and #7 as kind of the same, and I think the biggest potential is in #10.

With regards to #8, “reverse proxy” it made me think of Zscaler.

https://www.zscaler.com/resources/security-terms-glossary/wh…

Maybe Smorg or other more technical poster on this board could elaborate, but not clear to me if Zscaler also does reverse proxy or if they are saying their approach is better than reverse proxy. From that link:

"A better alternative: Cloud Browser Isolation
Increasingly, organizations are turning to agentless Cloud Browser Isolation (CBI) technology in place of reverse proxy deployment modes. This is because CBI allows them to avoid reverse proxy issues and breakages while still securely enabling the use of unmanaged devices—without the need for software installations on endpoints.

When a user accesses a managed cloud application, CBI virtualizes the session and renders content in an isolated environment in the cloud, sending only pixels of said session to the end user device. As a result, the CBI user experience is unchanged from that of the native cloud app experience, but it allows the viewing of content without permitting downloading, copying and pasting, or printing. Consequently, it’s the ideal solution for enabling productivity while preventing accidental data leakage, malicious data exfiltration, and malware proliferation via unmanaged devices—all without agents.

When considering CBI, it’s important to choose a vendor that has a proven inline platform and is a trusted leader in security. Zscaler is built on a cloud-native proxy architecture to deliver maximum security and performance. The company runs the world’s largest inline security cloud with 150 data centers on six continents that serve customers in 185 countries; it processes 160 billion transactions each day."

If the future will be split between reverse proxy and CBI, then perhaps a basket approach of ZS and NET makes more sense vs choosing one over the other. The issue is if one becomes obsolete or disrupted.

Dreamer

[willieram]

If you let me chime in with some reflexions on this excellent summary, I would say One A + Ten is the explossive combo. From what I could learn from this forum is that NET is building a next gen public cloud, at the Edge. They are leveraging the continous improvement in technology, like piggibacking on Moore’s law, and suddenly they are mounting a whole full featured, massive public cloud, by turning each edge node into a mini-cloud data center.

This is mindblowing, because not only you suddenly have an enormous cloud capacity, but you do with minimal latency and heavily distributed! So the customer experience is awesome.

I think this is what people is eyeing on NET, it’s still years ahead, but they are the first movers and the R2 is the end of the beginning, and the beginning of the new cloud era. We are talking about Cloud 2.0 (or Edge Computing, or however you would like to name it).

It’s like a new paradigm of implementing a cloud infrastructure not with massive data centers but with massively distributed mini-data centers.

Yes, I get it that some cloud services do need massive data centers to scale and become economically competitive, but I can easily see a whole bunch of services and use cases where this (new?) type of cloud is the natural evolution. And this is a huge business opportunity. If I recall right, Muji was all about this a few months ago.

[CMF_muji]

Hi all. I feel intjudo’s take (#10) sums it up in a sentence or two, but permit me a few more. https://discussion.fool.com/my-002-delivered-001-at-a-time-1-quo…

Here’s my take on why the stock’s valuation is so astronomical, as a response to Saul’s original question.

---

Saul,

Regarding NET’s valuation, you are certainly right to dwell on this question – the stock is shooting through the roof even as the actuals of execution remains muted.

I do see a couple of good signs in the financials, and if I didn’t see these I would be questioning the company’s ability to execute.
?

• ?Signs of architecture leverage: Yes they aren’t profitable but the trends are in the right direction and gross margins rise even as they add to their stack’s product lines and spread their networking interconnectedness.
  ?* Signs of GTM pivot to enterprise: accelerating RPO and enterprise cust growth, plus how US segment went from +50% to +60% (the main market they are selling Zero Trust and SASE into) shows it is working
  ?
  ?But those alone aren’t adding up to the irrational exuberance, as you so eloquently described it.
  ?
  I think it’s the signs of PLATFORM leverage that has everyone so in love with them. Which is where you started to go around tech oriented investors starting to buy into the vision. Quite simply, their architecture has a LOT of optionality. The CEO recently drew a line in the sand on how they think of their goals – that they can be the 4th cloud to emerge. (Right now, you are talking about a #3 Cloud with $20B run rate, and #1 with $64B.) ?Very lofty goal… but one that is visibly achievable with their stance, architecture, and, most importantly, their pace of innovation and software release.

But going beyond that – their platform can move in ways that disrupt a lot of different directions from here, so I expect their hypergrowth to accelerate and continue, as more and more adjacent markets get entered. Remember how they bolted on Zscaler’s capabilities early last year? That is just the start. Next up is going up directly against AWS, as a developer focused cloud w/ Workers and other primitives. In Birthday Week this year, they showed their plans against AWS in more clarity, with distributed object storage (and hints of more to come), and against Agora & Twilio in real-time video streaming. These are just the “edge primitives” for now, to allow them, as well as other developers, to take better advantage of the platform going forward – but like how SaaS was built over cloud, new products and technologies will get built on top of their edge network, aka a “global cloud over a programmable network”.
?
??The forward-thinking big institutional buyers are paying attention to NET now, and are amassing it, as seen in the ever rising price. They are buying into the vision laid out by the CEO and company, and are going to watch it play out over the next few years, to both watch that the company can cross the line laid in the sand as an “edge cloud”, plus then see what else can show up as added TAM from adjacencies.

Not surprised, however, if it drops out of your top 8-10 based on the current financials. It’s a longer term play and vision. So this might be a company that drifts in and out of your/others ports with the rules of your/their style – but I expect this will be a company to watch over the years, and should it exit your top 10, may reenter later when the revenue likely accelerates.

You and I held Okta a long while, Saul, even as top line growth dropped, given how good their position was in the enterprise SaaS ecosystem and Zero Trust. For a few quarters, I couldn’t find flaws in execution, so kept holding on as it scaled up profitability. However, in that particular case, they didn’t find the replacement to have hypergrowth continue onward in a sustainable way, and ultimately I found a flaw in execution (product cadence) to blame. Absent visible execution issues, it might be worth holding onto Cloudflare to see if they find the next hypergrowth lever over the coming quarters. And if they find that, I bet they find another, and another, and another.
?
?Hope that helps.

• muji

[Sansainoi]

Apologies if this has been posted but Peter Offringa at Software Stack Investing has an extended article on Cloudflare. The whole article, The Invisible Hand of Product Agility and TAM Expansion is very much worth reading. Regarding price action his major takes are:

Therefore, the only conclusion we can draw is that the price action was an outcome of the announcements made during Birthday Week. A segment of the market recognized the significance of what Birthday Week represented. I boil it down to two factors. First, an optimistic view would conclude that Cloudflare added somewhere around $100B to their long-term TAM. Recall the slide from Investor Day where they projected a TAM of $86B by 2022. The incremental TAM contribution of email security, WebRTC and broader cloud compute penetration doubles this over several years.

Second, they demonstrated that their already blistering product release pace is accelerating. While Cloudflare had been gradually increasing the pace of product development over the past 12 months, Birthday Week represented a watershed moment. The amount of innovation packaged into 5 days of release announcements eclipsed anything in the past. And management telegraphed even more to come.

Net is my 3rd largest position.

Best, Bob

[nilvest]

great summary…

FWIW - with NET focus bigger market and tremendous product cadence, I think Fastly is somewhat irrelevant now… and so is CDN market… NET is moving much faster than these.

Of the players we know, I think ZS is capable and likely rise to match its playbook with NET… has similar platform, architecture and network of edge datcenters… and just started to expand beyond its core security access products.
Question remains if they can step up in vision and delivering vast array of products required to become successful as a mainstream cloud IaaS / PaaS provider.

Make no mistake, both these companies will need to spend a whole lot more money, both cash and employee stock dilution to get anywhere near their vision… but for now, market is certainly believing NET is on its path to take on AWS.

[gr8skp]

All great posts, but one concept that I didn’t see come across in these comments is Cloudflare’s position in enabling Metaverse. The next technology that many companies are investing / developing including Facebook, Microsoft. Cloudflare already excels in edge capabilities, Content delivery, network security, video streaming, with compute and storage added to this mix it completes all the key architecture pieces required for developing the Metaverse and interact with users at low latency. IMHO Cloudflare with its current and ever-expanding product suite is well positioned to tap into this market.

I am a first-time poster have been following this group for the past 1 year and I have learnt a great deal and I am thankful to Saul and this community.

Hope this helps…

• gr8skp

[DoctorStrange]

These responses have all been insightful, but I’m concerned that if it takes a group of very bright, knowledgeable, and successful investors to come up with a list of things that might be the reason the stock is so highly valued and keeps going up, then I worry whether any of that is the reason.

If bright people on this board can’t come to a conclusion, why should I believe that the market somehow has figured it out, but this board hasn’t? When I can’t put my finger on a definitive reason, I worry. My concern is that some of the price action may be due to some non-business reason, like an influencer on Tik Tok or people hopping on a momentum train with zero knowledge of the business.

Or maybe it’s just that, no, there’s not a single definitive reason – it’s a collection of things.

I clearly am uncertain. I’m holding, and it’s not a small position for me, but I’m reluctant to add without a stronger feeling as to what exactly is driving the price.

[Smorgasbord1]

I’ve been traveling and so haven’t had time to prepare a proper answer, and given all that’s been said, I don’t feel a point by point confirmation/rebuttal is really going to help much.

My thoughts about why the stock has been rising, and will probably continue to rise into earnings (tomorrow!), center around really good communications from Cloudflare’s management. CEO Matthew Prince does a great job touting his company’s new products, even while having to admit those new products aren’t yet contributing to the bottom line. An example of that is from the Q2 conference call, where Prince described how the US government became a customer of Cloudflare’s Zero Trust solutions (via Accenture winning the contract, which included use of Cloudflare’s Zero Trust. After saying how great this all is, Prince then says: While we are proud of this deal and the credibility it gives us as a leader in the Zero Trust space and we believe it will ultimately be a significant contributor to revenue, we don’t believe that the contribution will be meaningful in 2021. (https://seekingalpha.com/article/4445757-cloudflare-inc-net-… )

Prince gives a couple/few instances where channel partners secured the deal that included Cloudflare. This is important as it reduces Cloudflare’s sales/marketing expenditures - they mostly need to work with the System Integrators, not each end customer - and any current holes in Cloudflare’s offerings are filled in with other vendors and/or custom solutions from the partners.

Prince then explains how Cloudflare is investing in expanding its network: As a result, this deal along with some other strategic deals we won in the quarter, do not show up in RPO and we have not included the impact of them in our guidance through the end of the year. However, servicing a large customer like the United States government as well as other strategic deals we won in Q2 does require us to increase investments in our network. Anticipating these deals, we began making increased investments in Q1. These investments continued in Q2 and we anticipate will continue through the second half of the year. We are investing for the long-term and we believe winning strategic customers proves how this strategy continues to pay off. Even with the initial investment, we still anticipate we will reach breakeven in Q1 of 2022.

With that, Prince has explained why the company isn’t yet profitable and won’t be profitable this year (company guidance is for another $0.03 to $0.04 loss for Q3), but it’s a story Mr. Market can understand - and like (that losses won’t be going on for years). For instance, their new storage initiative, R2, is going to require massive investment in disk storage on many of their POPs, which is why R2 isn’t just available to everyone yet - you have to sign up to request it. I suspect they’ll be somewhat slow rolling it out, and adjusting pricing along the way. BTW, Amazon already has competition for S3 - see this blog post: https://www.taloflow.ai/blog/will-cloudflare-r2-win-customer…

Note that Cloudflare doesn’t break out revenue per product service or even category (unless I’m missing something), so we don’t know what products are gain traction or not. Personally, this is my biggest concern. I assume, for instance, that the CDN business is a loss-leader to gain them future paying customers. Workers appears to be gaining steam, but hard to know on profitability. Edge Computing gets a lot of hype, but I haven’t seen a real-world, large-scale Edge Computing solution deployed. I’d love a pointer if anyone has one.

OK, just one note on technology and statistics. All the comment that “Cloudflare currently does 18.4% of the entire internet in regards to reverse proxy” shows is that Cloudflare’s free CDN service is really popular (CDN’s typically use reverse proxies). And, not every website needs or can even use a CDN.

Back to the original question, Cloudflare has strong technical offerings, introduces new offerings at an amazing pace, and has superior investor and potential customer communications. Additionally, they apparently have lined up a number of SI/GSI partners to sell their products as part of their solution, which is a tastes great/less filling approach to sales (others do this too, of course). Getting Mr. Market to understand why they’re still losing money, but won’t for much longer has been a big win for them, and their CAGRs for revenue and paying customer count are really really good (over 50% YoY). Not all of their new products need to hit, and the company is being responsible with controlling the flow of customers into the new offerings, which need time to scale, and I expect, mature as well. Q3 last year had a one-time $1.9M customer renewal that’s going to hurt the YoY comps for Q3 (revealed tomorrow), but they’ve already set expectations for around 45% growth with that (48%-49% without it).

[NunuTheNunu]

Hi, it might be late but hopefully I can put my 2cents in. I have some tech background, use to be contributing to open source projects, but now just following as day time work took all the time. Web Dev was not really something I had change to learn 20 years ago, so I will try my best here.

About R2 platform. There are a lot talk about Edge Computing/Network recently, not really because it is new, but more imho because the rising of 5G and IoT potential on different industries. R2 platform from my understanding of their new releases is taking full advantages of Edge Computing as well, which would (probably) also explain why they won’t charge for data egress, as the data is egressing from edge device instead of the actual cloud. I think it will be very powerful/or game changing when combined with 5G and IOT (cars, face recognition, VR gaming - Ready Player 1 style). It will go hand in hand with Metaverse, if you believe Metaverse will be big.

There also is a lot talk about Confluent recently. Initially I thought those 2 companies might be direct competition in some ways. But now I think they could really synergize if they would support each other - hopefully we can see this in the near future.

AWS, Azure, Google Cloud indeed have similar Edge computing product, but it seems those are more of add on features, where R2 has this integrated within.

Just my 2c. hopefully not off topic.