Cloudflare Inc (NET) Q3 2021 Earnings Call: Q an

My notes:
-Cloudflare studied the feasibility of offering R2 storage service by looking at the usage of network from its huge customer base.
-The customer interest in R2 is huge.
-The competitive advantage for R2 is Cloudflare’s distributed network is ready in terms of: 1. Sufficient compute power. 2. Sufficient Storage space. and they can scale up quickly if demange is more than expected.

  • Low bandwidth cost: the R2 service will run on edge servers around the globe. So there will always have severs close to end users. The result is shorter distance for data to travel and low bandwidth cost. (Longer distance increases signal loss and data transmission cost)

-Cloudflare is prepared for two scenarios : 1. Be the fabric connecting other pubblic clouds 2. Make R2 storage as good as other public clouds.

1.Matt Hedberg – RBC Capital Markets – Analyst

Thats super helpful. And then I have to ask about R2. Obviously, that was a really exciting announcement this quarter. I know its going to take time to impact the model. But perhaps you could talk a little bit more – double-click on really how this positions you guys as really an edge cloud provider, even more so now with R2?

Matthew Prince – Co-Founder, Chairman & Chief Executive Officer

Yes. So R2 for those who might not be following along as closely, Matt, is our object store. And if you think about what are the key components of being a cloud provider, you have to have compute, but you have to have a way also of storing data. And some of those things are databases, which were building out in various ways. Some of those are also ways that you store objects. So those are like files that would be at the edge. And as – because of where we sit, where we are the network in front of many of the large – largest cloud providers customers, we were able to really study how customers were using various cloud providers. And we came to the conclusion that the right thing for us on our product road map was to build an object store. And one of the things that is unique about where we sit versus some of the more traditional and legacy cloud providers is that because we are distributed at the edge, it allows us to be significantly more efficient in the bandwidth usage that we have.

And so while typical cloud providers have to pay a series of middlemen to deliver from Ashburn, Virginia to the other side of the earth, we are already on the other side of the earth, and we have usually a direct connection to all of those other networks that are there, which means that we have an inherent competitive advantage in terms of the cost of bandwidth delivery that we can provide. And so we see that as – we see that because of the fact that we have that attractive pricing, we should be passing that on to customers. And were excited for building out R2 and seeing how that further enhances our Workers platform, which every day, people are building more and more complicated applications on. And I think this is going to allow that to just accelerate.

Alex Henderson – Needham – Analyst

Great. I was hoping you could talk a little bit about the scale of the TAM implied by the R2 product. I mean, clearly, its a big opportunity, but its hard for us to really grasp the scale of that opportunity since most of the data associated with revenues would be masked underneath the larger companys business. And while youre at it, if you could talk a little bit about the Bitcoin, blockchain announcement, email announcement and net for offices, whether – what does that add to your potential opportunity that would be very helpful as well?

Matthew Prince – Co-Founder, Chairman & Chief Executive Officer

Alex, thats a mouthful of things to go through. We had an entire week of announcements, and I think you just listed all of them for me to summarize. But let me start. So I think that its early days in terms of R2. But what I think that we hope is that R2 can be very disruptive in the market and not only allow us to capture more of the object store spend, but also put downward pressure on all of the different cloud providers to eliminate their egress fees. It is completely absurd that companies are charging nothing to send data to them, but then charging what can be massive markups, 80 times what the wholesale price is to take data back out. And we dont think thats sustainable, and we want to push that down. The reason why thats attractive to us is we think that our long-term opportunity is really to be the fabric that connects together the various cloud providers. And in an ideal world, what we hear from customers is that they want to use some Cloudflare services, but they want to use Google services and Microsoft services and Amazon services and pick the best of what they need across all of those different providers in order to deliver a more robust application.

And I think that is the inevitable way that the market will play out over time. And that being that fabric that can connect those different networks together is a very powerful position for us to be in. And so R2 is both, I think, an opportunity for us to grow TAM. But its also an opportunity for us to accelerate what I think is the inevitable next generation of the cloud, which is allowing customers to pick the best of breed across multiple clouds. And Im optimistic that across the entire industry, if we really do encourage competition on a feature-by-feature basis and we dont lock customers in, in artificial ways like charging for egress but not ingress, that actually will expand the TAM of the entire cloud industry. And so Im bullish on kind of everyone whos in this space.

Shaul Eyal – Cowen – Analyst

Got it. Understood. And maybe one more on R2. I know its absolutely early days, but how would you characterize the level of sign-ups so far?

Matthew Prince – Co-Founder, Chairman & Chief Executive Officer

Off the charts. I mean, I think that we were surprised by how much it resonated across the customer base. We usually, during these Innovation Weeks, see an uptick in our inbound interest. But in terms of the organic leads that we saw, as I mentioned in my prepared remarks, we saw a tenfold or 10 times increase in the number of organic inbound interest. And I think it points to that customers, whether theyre small or large, feel like the egress fees that theyre being charged by the sort of legacy cloud providers are agree to, and theyre looking for a solution. And if we can help provide that, I think thats a very exciting opportunity for us.

Amit Daryanani – Evercore – Analyst

Okay. Thanks. Im glad I made it under the line there. I guess I have two, theyre both on R2 as well. Matthew, Im wondering if AWS tomorrow was to take the egress fees to 0 in theory, what would the value proposition for R2 to become in that scenario? And Im trying to understand what would you say of the reasons one should go to R2 versus AWS beyond the egress fees?

Matthew Prince – Co-Founder, Chairman & Chief Executive Officer

If AWS takes egress fees to zero tomorrow, I will do a dance of joy for all of our mutual customers. And that will put us in a position, I think, of finally realizing what is the ultimate opportunity of the cloud, which is how do we allow customers to take advantage of the best of what Amazon offers, the best of what Google offers, the best of what Microsoft offers, the best of what Oracle offers and the best of what Cloudflare offers. And if we can be the fabric that connects all of that together, thats great. In the meantime, because I dont think that AWS is going to take egress fees to 0 tomorrow, were going to make products that perform at least as well as theirs do. But dont rate customers over the cold for what are agreed just egress fees. So I hope that your hypothetical comes true. I think its unlikely that it would, but that would be a great thing for customers. And I think it would force us to continue to innovate in that space, just like it would force everyone else to innovate in the space and who wins in that case is customers.

Amit Daryanani – Evercore – Analyst

Fair enough. And then I think you probably talked about the goal has eventually become the fourth major public cloud. And I think – and Im curious, to be that, what does that do to your TAM, which youve talked about being $100 billion in a couple of years? What does it do to do that? And then what sort of capex investments do you need to make to achieve this goal?

Matthew Prince – Co-Founder, Chairman & Chief Executive Officer

Again, I think the good – taking the second part of the question first, the good news is we’ve made substantial capex investments around the world. And the efficiency of running an edge network like ours is actually substantially lower capex versus traditional centralized cloud providers. We get the benefits of taking advantage of the entire Internet and the routing system around the world and then can put data wherever it makes the most sense for customers and store it there. So we’ve got substantial storage and compute capacity across our entire network. One of the things that was important about the fact that we started out very much as a security company is that security applications require significant compute. And so we have actually deployed, unlike some of the more point CDN solutions, when you look at our notes, they’re very heavy on compute. And thats part of why we’ve been able to scale up our computing solution as quickly as possible. They also have a ton of disc in them. And so that means that there’s storage that we can provide in those locations. We’re confident that we can provide the R2 service in a way that has very attractive economics for us. And we’re also confident in part because our infrastructure team has gotten so good at building to the capacity that we need that as – if we do see demand, which is significant that we will be able to invest in capex behind that demand. So I dont think that as a percentage of revenue are to meaningfully change our capex spend. But it might – but if it is wildly successful, our capex might go up, but that would be correlated with our revenue going up.