First of all, I was hoping to get some engagement in this thread and I was not disappointed. So thank you all for sharing your perspectives!
I wanted to address one specific criticism that kept coming up. I’d summarize it as a criticism about how Cloudflare’s leadership is running their business and that there might be a castle in the air narrative that’s not backed up by the numbers.
First, let me point out that this is not the first time the board has criticized Cloudflare for “just wanting to make the internet a better place”. Just a few years ago Cloudflare’s management was criticized by some for “never wanting to make a profit” (that was when they were still unprofitable). Looking at today’s numbers, that criticism was clearly not justified. And yet, here we are again, with very similar arguments. Arguments that the narrative is deviating from the numbers. Well, the good news is, why argue if we can look at the numbers?
As @stocknovice said:
I certainly agree with the first part of that sentence and everyone should make up their minds about the second part. To help us do just that, and since Cloudflare’s willingness to make profits is questioned here, let’s compare the numbers to some of the world’s best companies in the data and/or cybersecurity business:
Let’s start with operating income and operating margins of Cloudflare, Crowdstrike, Datadog, Zscaler and Snowflake as a function of their corresponding quarterly revenues:
Judging from that, I would argue that Cloudflare is on par with Crowdstrike, which by itself is already quite an amazing feat. Next, let’s have a look at net income:
At it’s current revenue, Cloudflare has already overtaken Crowdstrike, Zscaler and Snowflake.
Finally, let’s have a look at free cash flow, and I am plotting TTM (trailing-twelve-months) here because it is fluctuating much more QoQ than the other two profitability metrics:
Now, here Cloudflare is clearly the laggard. But I think there is a good reason for this:
The way Cloudflare “pays” for this advantage is through purchases of property and equipment which is the main line-item of which net cash provided by operating activities is reduced by, to arrive at free cash flow. In case you wonder how far Cloudflare’s FCF margin might go, I can’t tell for sure, but management’s long-term model says they should exceed 25% FCF margin. I think the narrative here is that all those initial Capex dollars will eventually pay off. Again, we don’t need to guess here, because the numbers tell a clear story:
Here I am showing you TTM FCF as a function of TTM network Capex. Remember the time when critics questioned Cloudflare’s ability to increase FCF without increasing network Capex? Well, that was during the what I call “Initial Investment Phase”, highlighted above. As you can see, once the hardware was installed it just needed to be sustained at a fixed cost level, while free cash flow started sky-rocketing. And in the last two quarters TTM Capex even dropped while TTM FCF kept going up.
Now, if this doesn’t look like a money-printing machine to you, then I don’t know what will…
Just think about this for a second. Cloudflare has proven, that they are able to scale FCF without having to increase their infrastructure investments! That means they can literally print money and given the efficiency I see here I don’t think 25% FCF margin is the limit.
So, what comes next? Well, management told us, in order to seize the opportunity of future AI revenue and AI FCF, they are going to increase their network Capex spend to 10-12% of revenue in FY24 - I guess mainly in order to increase the computation power to maximize AI model inference capabilities in their one-of-a-kind worldwide distributed edge network. How this will turn out is anyone’s guess, but the fact that they have shown their business model can not only work, but do so with incredibly high efficiency gives me quite a bit of confidence in their business model.
-Ben