My favorite rock bands loved to live on the edge - drugs, sex, fast cars and destroyed hotel rooms. Some of them (Guns and Roses) got too close to the sun and melted away. Others (Aerosmith, U2) had staying power to become some of the greatest of all time. Cloudflare reminds me of these musicians that produce awe inspiring work yet could crash and burn if one or two or three things go south.
I am trying to understand how a technology company, on the forefront of the adoption of cloud computing and the growth of internet, can deliver such consistency in revenue, gross margins and market share, while having anemic cash flows.
I realize that they are investing in R&D and sales; they are expanding their product and services suite and grabbing marketshare. However, at some point, you have to stop giving away the shop and make money for the shareholders - who, btw, are your primary stakeholders.
Read the opening comments by CEO, Matthew Prince - “we are not in a rush to be significantly profitable”…“we have done something wrong if we beat significantly on EPS”……smh
Investing in NET takes a bit of faith in the future. Prince promises that they are dialed in and H2 2022 will be better. My patience is running thin.
Here is what stood out to me in NET’s Q4 earnings report: (Link to detailed financials map below)
Revenue growth - Q4 revenue grew 54% YOY and 13% sequentially QOQ. 2021 annual revenue grew 52% YOY. NET guided for $206M in Q1 2022 and $931M in full year 2022. Deferred revenue grew 113% YOY and 27% QOQ to $117M - this metric has accelerated 4 quarters in a row now! NET has beat guidance by 4-6% for several quarters now - which is a sign of a deep revenue pipeline, effective sales force, DBNRR strength and mature fiscal mgmt.
Profitability - Gross margin has been steady in the high 70s for 12 quarters now - another sign of a highly efficient product set and strong pricing power. EBITDA is trending towards positive for 3 consecutive quarters. However net profit / loss remains lumpy and operating margin remains high in the -20s.
Cashflow - Cashflow remains all over the place. Operating cash flow increased to $41M for Q4 and $65M for the year 2021 (482% YOY). Free cash flow also jumped to $9M for Q4 and -$43M for 2021 (53% improvement). The roller coaster ride in free cash flow margin shows where NET needs to improve, especially in the light of the high debt to cash ratio.
Market share - Customers like NET’s products and they keep buying more. DBNRR has improved for 6 straight quarters and sits at 125%. Customers with > $100k contracts have been growing by 70%+ for 4 quarters and by double digits for 7 quarters in a row. Customers with >$500k contracts grew 70% YOY and $1M+ customers grew 75% YOY. And I love the global growth trend.
Debt - remains high at $1,294M versus cash at $1,822M. This is a bit too close for my comfort, especially given the uneven cash flows. They should have no problem raising funds if needed, however this leads to further erosion of shareholder equity and keeps the share price in check.
Product - NET is building a better internet, enabling broader, quicker migration to the cloud and improving the consumer’s experience. 250+ cities, 100+ countries, 10,000 networks, touching 95% of the world’s population - the numbers are easily overwhelming. They keep the product improvements rolling, more frequent than any other company, supported by the mass free testing by the large developer community.
My conviction in NET stays the same with this Q4 2021 earnings report, however like I mentioned above, my patience is running thin. I re-scored the company using my analysis method and their score increased by 1 point aided by the positive trend in EBITDA improvements - a small sign of hope.
Elevator pitch - I own NET (6.5% position) because they are the most innovative cloud and internet company that I am aware of. I am intrigued by their edge computing roadmap, cyberthreat (zero trust) services, IoT and 5G opportunities. At some point, lots of everything else becomes a commodity and the telcos, hyperscalers, AWSs etc. start undercutting them.
I boarded the Cloudflare train in 2020. I am not fully convinced that they can get me to the promised land.
Detailed financials map https://twitter.com/Iwannabeontheb2/status/14975772637973463…