CloudFlare - Narrative leading numbers?

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1

Hi all,

I was looking for $195m in revenue, and they hit $194m. It’s a rounding error, but $195m wasn’t a super high bar.

Their DBNRR was strong.

Stock-based compensation is also ticking up. Operating margin was down, due on an uptick in R&D.

So going into the conference call, I was a bit “it was fine”.

However, my main takeaway from the conference call was traction in the zero-trust, security of networks side of things. This was one of the things I was always waiting for with Elastic, Fastly etc., who have the products theoretically, but never seemed to have the customers.

“A F500 customer signed a $250k contract for >10k zero-trust seats”

“F500 Pharma 3 year $750k network security deal”

“Innovative payment startup 3yr $1.5m for network security products”.

Similarly, the fact that they have a backbone network which can avoid the public internet altogether (for corporate networks for example) appears a truely valuable asset. Workers seems to have traction, the zero-trust side of things seems to be growing well…

I’m unclear whether this is “better” than ZScaler for example, but if you can route completely separately from the public internet, over a backbone network thats completely within your control…?

And their mission “future of the corporate network” and “building a better internet” seem to be timely.

So on one hand, the numbers weren’t amazing. On the other hand, they seem a company of a better future. Maybe the narrative leads the numbers?

cheers
Greg

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2

Hi Greg,

I believe the attraction of Cloudflare lies in its continued product innovation and velocity; and hence the durability of its growth profile. They may not print 70-80% a year of revenue growth but they have (and investors think) it can maintain 50+% growth per year for many years to come (including 2022, as implied by their guidance). Infrastructure software like cloudflare generally has less competition than application software (like CRM software) and is very sticky and technically harder to scale.

Cats
=^…^=

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3

I don’t agree that narrative is driving here. WSM put a great post on the numbers and I agree that numbers are good.

In fact, Cloudflare is showing a great EXECUTION in their business. Narrative is there only in respect of surfing the safe internet (cyber security) and cloud adoption tailwinds. But this is valid for all our companies. Cloudflare support this narrative by great execution. This is very important.

Second important element is CONSISTENCY . This was mentioned many times but still perhaps sometimes underappreciated by our board but appreciated by the market. The market was, is and will be valuing consistency ABOVE the same CAGR but achieved in an inconsistent manner. If a company will be doing 50% growth each of the past years and is expected to do so in the future it will be more, probably significantly more valued than a company growing annually at 30%, 50%, 70% then falling back to 50%, 30% then returning to 50% etc etc. U get the point - consistency is valuable for the market and this is a fact. We can be sceptical about this if we want but this would mean disregarding or underweighting the facts. We are investing based on facts - hence disregarding Cloudflare’s consistency is in principle not in line with our approach. IMO we shall be taking the consistency in Cloudflare execution seriously.

Best,
V

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Great post.

I think we are all in agreement that this is an elite company with brilliant leadership, solid vision, strong numbers and has a high likelihood of growing meaningfully over the years. But also that it’s simply not growing as fast as others.

So, the real issue here is allocation. Every fiber of my narrative-loving behind is screaming at me to make this a 30% position. I think of all our stocks this is the least likely to suffer a self-inflicted, major, and permanent, drop. BUT I respect this board so much, that when I see veterans keeping allocations closer to 5% than 10, 15 or 20%, I check my enthusiasm. And am keeping it around 12%.

I was excited about what I saw as a great narrative in Twilio, but when I saw little-to-no enthusiasm for the pick, I realized my narrative bias was not serving me well and sold out. That turned out to be a great call and one that is modifying my excitement for NET the stock. Again, if the numbers ramp up, and NET innovates wildly yet again, we will have plenty of time to up our allocations. This is a huge lesson for me having been on the board 4+ years now. That if you over-allocate and take a hit, it can be very, very painful and damaging to your port. Letting the companies earn high allocations is critical.

To me, the great power of our board at its best, is the many lift up the one. The real choices are- -

  1. Avoid NET - Don’t buy the story, or hate the valuation
  2. Small Allocation - Love narrative, respect co, want more proof from numbers
  3. Moderate - Intense love for narrative/company, belief numbers will come
  4. Large - Love story so much just have to be in for a big position, willing to wait for glory

1 and 4 are too extreme. 2 is entirely understandable but just not enough for me with such a solid, consistent, visionary company. So, again, that leaves 3. At times the numbers do come from spotting a great Narrative first. And I’ll be happy to see this earn its way into a top allocation.

BD

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Dan, a great post on how to think about allocations among our companies.

If I’d be using ur framework - for NET I’m going into Box Nr. 3 as well. I keep now 11% allocation and in principle am OK with keeping around 10% position for NET considering all the elements of NET investment thesis and other available alternatives (aka horses). I think that it’s likely that Cloudflare should be accelerating into mid to high 50s this year as base case scenario and into low 60s as best case scenario.

I do have only 1 company that falls into Box Nr. 4 presently - it’s our old friend DDOG! After such monster quarter and expected continuity of HYPER growth who wouldn’t be keeping such a company as a or the top position in a concentrated hyper growth portfolio! :slight_smile: Long DDOG 22%.

Best,
V

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