What am I missing with Cloudflare

Investment Analysis Clubs Saul’s Investing Discussions
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I have a question for all of you with regards to Cloudflare. It has almost doubled in the last four weeks and is now valued even higher than Snowflake. I am happy with the rise. I don’t sell out because the stock price is going up. I don’t have even a thought of selling out of my position. But I just keep wondering WHAT AM I MISSING ABOUT THEIR BUSINESS??? This has nothing to do with valuation. I’m just puzzled about what I don’t understand about their business.

When Snowflake shot up to $400 the reason was evident. They were growing at 120%, they had just had this incredibly explosive IPO, and everyone and his taxi driver was talking about Snowflake. That was irrational exuberance!

But here is Cloudflare, growing at ‘only’ 53% or so (I say ‘only’ advisedly. It’s the SLOWEST GROWTH of all my stocks!) No one except techies and SaaS investors has even heard of the company, or can describe what they are doing. This is not what irrational exuberance looks like.

What are we missing??? What are techies seeing that I can’t ??? Why is everyone picking a 50% grower to bid up, that isn’t even accelerating growth, when they aren’t doing the same for our 60%, 70%, 80%, 90% growers??? What an odd choice of a company for irrational exuberance to bid up to the stratosphere!!! Again, WHAT AM I MISSING !!!

It’s awfully hard to blame irrational exuberance when there is nothing about the company to be exuberant about. Let’s look at it:

The LOWEST REVENUE GROWTH of all our companies!
NO REVENUE GROWTH ACCELERATION!
Profit is negative, LOSING MONEY!
FREE CASH FLOW is NEGATIVE while almost all our other companies are positive!
NRR was okay but really just SO-SO, at 124%, and certainly nothing to get exuberant about!
NOT YET FEDRAMP certified!
etc
etc

WHAT’S to have IRRATIONAL exuberance about??? What’s to be even MILDLY exuberant about? There isn’t any metric you can look at that says ‘Let’s be exuberant about this company’.

Put all of those metrics above together and you’d say that this is THE MOST PEDESTRIAN, UNEXCITING COMPANY you can find in our portfolios. This is NOT irrational exuberance!!! There must be something real pushing up the price. That’s why I keep asking “What am I missing???”

It makes me convinced that smart TECH people out there are seeing something happening with Cloudflare’s business, with what it is doing, that they aren’t seeing with our other companies. Almost has to be! I can’t think of any other explanation.

My guess is that it’s Cludflare’s own internet that they are creating that is exciting all the tech oriented people. A safe internet without breaches. This would represent an almost infinite TAM. But that’s just my guess. A year ago (as I think I remember), they were saying that 17% of all traffic on the internet went through their computers, by now it must be at least 25%, maybe more.

I’d welcome other explanations. Please don’t give me any valuation comparisons. That’s not what this is about. It’s about what we aren’t seeing clearly in Cloudflare’s BUSINESS !!! In what they are doing!!!

Thanks for your help.

Saul

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Here is what I have heard on various developer forums.

Developers are excited about this new offering, Announcing Cloudflare R2 Storage: Rapid and Reliable Object Storage, minus the egress fees.
https://blog.cloudflare.com/introducing-r2-object-storage/

"We’re excited to announce Cloudflare R2 Storage! By giving developers the ability to store large amounts of unstructured data, we’re expanding what’s possible with Cloudflare while slashing the egress bandwidth fees associated with typical cloud storage services to zero.

Cloudflare R2 Storage includes full S3 API compatibility, working with existing tools and applications as built."

As transformative as cloud storage has been, a downside emerged: actually getting your data back. Over time, companies have amassed massive amounts of data on cloud provider networks. When they go to retrieve that data, they’re hit with massive egress fees that don’t correspond to any customer value — just a tax developers have grown accustomed to paying."

SUMMARY: It’s a tool that will allow developers to lower the costs associated with data transfer on AWS S3. Amazon charges not just for the storage of data, they also charge transfer fees. Cloudflare’s R2 will only charge for storage. It has no transfer fee. Which could save companies a huge amount on fees.

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. It could disrupt certain aspects of AWS.

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This may be something, could be completely nothing.

We may recall that one of their main competitors with leading edge tech was Fastly (FSLY). While Fastly has been floundering, as an investment and as a company, Cloudflare hasn’t. On this board there was extensive conversation regarding each as an investment, as well as each as a technology. One of the biggest differences between the 2, as talked about much on this board, is the leadership.

Also keep in mind that Cloudflare has been investing too. In its infrastructure, in its product offerings, in its goodwill. That also doesn’t go unnoticed. The popular saying of following the numbers does have a caveat, which is to consider the potential. All of our companies has the potential to fail, and all of them has the greatest of potentials to succeed. What we may be seeing is the collective confidence that Cloudflare is going to massively succeed.

Anyways, ignoring the numbers, that is my take.

Griz

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In re egress fees,
there is a robust discussion at ycombinator. CEO, Prince(eastdakota) responded to ideas/suggestions. Link:
https://news.ycombinator.com/item?id=28702997

nindalf’s comment, I think, is spot on:
AWS could announce something that counters only this, perhaps making egress for S3 alone cheaper. But they won’t make egress itself free or close to free because egress is what keeps you checked in to Hotel California.
Removing egress feed is not just about taking a massive hit to revenue. If it was, they might bite the bullet and hope that the lower prices would attract more customers in the long term. But bandwidth pricing is the moat around their castle. If it didn’t exist, Snowflake and others would leave. But more than that, new AWS services benefit from the captive audience choosing them by default. Without the moat, each service has to compete on its merits. AWS Lambda, for example would need to be better than CloudFlare Workers or fly.io containers. It won’t win customers like it does today just because it’s “free” bandwidth.

They won’t rush to announce anything that might affect the foundation of their multi billion dollar money printing machine. They’ll take their time and see how customers react. If any large customer threatens to leave, they’ll be offered credits to stay. But that information about what customers want and what they’re likely to do will help them come up with a strategy.

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“No one except techies and SaaS investors has even heard of the company, or can describe what they are doing. This is not what irrational exuberance looks like.”

But is this still so? I don’t know for sure, but this may have changed. I don’t have reliable info about the status of NET on Reddit and the like, but I bet someone on this forum can trace the popularity of NET on public forums rather quickly.

What I do know is that two weeks ago or so, muji and Peter O trumpeted the virtues of NET during a Florida investing event and around that time the last price push began to occur. A week later, Fidelity threw at me a news message proclaiming NET to be a Reddit gainer stock. I did not spend much time looking into that but when I googled it on the day, NET came out as #10 in some sort of Reddit stock list. Besides, there has been a lot of NET-ing about NET on Twitter.

I am not sure what to make of the CEO’s tweeting habits and especially in relation to product analysts. While it makes sense to show appreciation, is it really the CEO’s job to deal with that on Twitter? I don’t know, but it is awkward to me.

As for the business, thanks to the fantastic coverage offered by muji and Peter O, I don’t feel that I am missing anything about the multi-pronged thesis. I am surely missing a lot about the numbers in relation to the thesis.

Considering that NET only managed around 150 mil last quarter on many revenue lines including zero trust while ZS managed around 30% more on just zero trust, the delta between story and numbers seems rather huge to me.

What I would like to know about the business is how NET will pull out its David vs Goliath fight with the Big 3+ Verizon and ATT for edge dominance. I have seen arguments as to how it could be done (guerilla style warfare with the help of developers vs the cloud infrastructure establishment), but I would like to see someone provide examples of actual wins and progress in this direction.

I have seen developers explaining why NET is so friendly to them (like not forcing them to re-write code after upgrades) so there is that on the plus side.

In any case, I find the NET thesis/TAM growth/numbers/stock price a fascinating topic. What is certain is that I don’t have any idea of how to make sense of it all. I guess the glass half full view is that the stock is simply running way ahead of a realistic but slow to develop thesis while the glass half empty look would be that the thesis itself is not all that realistic in the first place.

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Thanks so much to everyone contributing thoughts and possible explanations. I greatly appreciate the assistance.
Saul

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Saul,

As someone who never understood Cloudflare either, I’ve taken some time to research the company in attempts to hopefully provide one possible answer to the market’s exuberance of late. In full disclosure most of this information is taken directly from Cloudflare’s website, which I broken out into basic examples.

What does Cloudflare do?
In its simplest form, Cloudflare is a content delivery network (CDN). The purpose of such acts as the middle-man between say, the Netflix master servers, and your local internet servers. For example, lets assume the master Netflix servers exists in Denver, but you live in Los Angeles. A Los Angeles based server attempting to reach and stream 4K or HD quality video all the way from Denver is still, even in 2021, a big task. To combat this large workload, a company such as Cloudflare would place geographically distributed servers closer to your area that speed up the digital information transmission.

How is this beneficial?
Speed. Using the example above, instead of pinging a server 1500 miles away, you are doing so at perhaps less than 100 miles away. Now say there just happen to be two servers in your area, and 10,000 people are all watching Netflix. Instead of overtaxing one server for 10,000 people, a CDN can recognize and flex high workloads across multiple servers, thus ensuring a smooth stream for all.

Reliability. The internet is nothing more than a string of Christmas light wires connected to machines all around the world. When a few bulbs go out, do you want to trace the problem through a run of twenty daisy-chained light strings, or three? Not only will you find the problem faster, but the other seventeen strings will still act normally while you troubleshoot. Think of this like redundancy on a commercial airplane. If one engine stalls, the plane can still fly until the engine is restarted, or repaired later upon landing.

Cost Savings. This core principle is a bit harder to explain. Essentially, each time the master Netflix server is asked to perform a task (stream your movie) it costs money to do so. A CDN located much closer in your area however can ping the Netflix server one time and store (cache) all that data. So when you go to watch Netflix you aren’t asking the master server to do any work, you are asking the CDN that already has the data ready to go. Its much cheaper asking the CDN to perform your request than asking the master server.

So why the exuberance?
Without going on for thousands of words, think about the Facebook outage that happened on October 4, 2021. For six hours or so, no one could access Facebook, Instagram, Messenger, etc. Now this means very little to people like you or me, but I have extended family members living in the Phillipines that only communicate using Facebook Messenger. They wouldn’t even know how to text, much less have the means to pay for a long-distance phone call to the United States. What if during that time there was a family medical emergency where major decisions needed to be made? People legitimately RELY on Facebook, and get to use the service for FREE.

Flipping the coin, and looking at this from Facebook’s point of view, how much advertising money did they lose because their service was off-line during that time? Millions? Billions? How many users (and I’ll admit, probably close to zero) decided to switch to another competing social media site during that time? But what if outages kept happening, and Facebook was always down? People would certainly flock away, which of course would be devastating to Facebook’s REVENUE and VIABILITY.

The Facebook outage happened on October 4th. Looking at the stock chart for Cloudflare, that’s the exact day it began its run up from 115 to where it stands today. Not a coincidence, and no clearer sign of the importance of companies like Cloudflare.

Brandon

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Here’s an angle that hasn’t been discussed much (link below, straight from the Cloudflare blog).

The internet can’t be thought of as a great big open ocean anymore. What China accomplished with the Great Firewall will be replicated across dozens if not hundreds of jurisdictions, and Cloudflare’s Jurisdictional Restrictions for Durable Objects are the tool to build and deploy for a balkanized internet. This is one of those cases where AWS is just too big for this new reality. (No, I’m not saying AWS is vulnerable, just that Cloudflare can take better advantage of this aspect of the way the internet is evolving).

https://blog.cloudflare.com/supporting-jurisdictional-restri…

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I’m in the tech world (large software company), but my group is not R&D (we are in consulting, implementing the solutions) and even here NET is not that well known. It really is in the niche of developers. Essentially, all software tools’ providers are trying to capture the hearts and minds of developers and being liked by them is super important, as incumbency is powerful in tech.
To the facts: NET is a CDN (content delivery network) leader. CDN basically is a network of servers, which essentially makes data available geographically closer for a fast retrieval when requested. You might recall in the infancy of Internet that accessing a “.com” was much faster than accessing a “.com.fr”. CDNs replicate this data across regions to be easily accessible. CDN’s importance is increasing dramatically because the data transmitted and stored in the age of AI and Machine Learning is beyond ridiculous now.
I must admit that eliminating egress charges was brilliant, but it’s also dangerous. Those fees are there for a reason.
Beyond CDN, NET started a LOT of new service offerings. And because it’s a sweetheart, people feel excited with everything it launches (think Tesla’s Cybertruck). You go to NET website, click on solutions, you see a bunch of stuff, with SASE and Zero-Trust, as examples, right there. They are not leaders in these spaces. They just launched a lot of those offerings. They actually list the stuff they are already good at lower in the page (protect and accelerate networks, build, deploy code at the edge, and manage cloud deployment).
I have no idea if they will be successful at all these offerings, I even believe they will. But I also know that when we launch a new offering at my company, it takes a year or more to make a small dent in the market (incumbency, again). In the meantime, NET is taking on a fight with AWS, the poster child and textbook definition of scale (in IT, scale and reliability are EVERYTHING, even more so in the SAAS world). Will it win? I have no idea. They might be as awesome and innovative than Amazon was, but for now I exited NET until the revenue streams are more clear to me, as well as clarity about how much CAPEX they will need to cough up to build the scale they will need (and yes, I already missed a 22% rise, but that’s ok). Don’t follow me, I’ve been more serious about investing for just a little over a year and pretty much all of you are better at it than me. I’m just sticking to my 25+ years of IT experience, which is probably a curse more than a blessing as an investor.

Rod

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Just my read…
I believe NET is getting benefit of CEO articulating vision (and delivery R2 as first step to match that vision) of becoming that 4th hyperscalar / cloud / IaaS company (after AWS, MS Azure and GCP).
Does not surprise that Reddit crowd may be getting on it as well.
Its that narrative thats driving price in short term…
for sure (IMO) numbers will fall far short of narrative in the short term… but if they succeed in their vision, current valuation can prove to be very small… though it can take a few years from now.

So how to invest in this? - I am expecting a roller coaster ride… small position to short trigger for now… and ready to jump in with both feet if opportunity arises to buy significantly below current price.

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I hope this information helps as well.

I found this recent seeking alpha article that talks about 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”

A table provided in the article shows that NET currently does 18.4% of the entire internet in regards to reversy proxy. Second is Fastly with …1.7% showing an enormous advantage. It goes on to say that …
"But the huge majority of sites, 77.2%, still doesn’t use a reverse proxy serve service. If you look then at the websites that use a reverse proxy, you see that Cloudflare’s market share is more than 80%. Mind blowing!

hope this add some insight.

https://seekingalpha.com/article/4463158-cloudflare-net-stoc…

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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.

The naming of R2 is pointeddirectly to AWS S3. 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 past the saving to customers. So what AWS is going to do?

  1. Do nothing: it’ll lose lots of customers.
  2. Reduce Egress fee. It’ll lose fewer customers but still lose customers. This shows its weakness and it feels threatened by a small guy like Cloudflare. This reduces the value of their brand.
  3. Remove egress fee. This will shows complete weakness to a small guy Cloudflare. This reduces more the value of AWS brand. And Cloudflare can continue to expand to other markets.

If Cloudflare succeeds taking some share from AWS, it can takes 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 starts to accelerate in the next few quarters. The market is forward looking. The stock didn’t went 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% during the forecast period. " - marketsandmarkets

“Worldwide Public Cloud Services Market Totaled $312 Billion in 2020 with Amazon Web Services and Microsoft Vying for the Top Position Overall, According to IDC”

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

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To sum-up - current move of NET as to taking on Public Cloud players was HUGELY appreciated by the market. I guess the sentiment implies that they will be a serious player in public cloud in the future. I also think that NET CEO is one of the best story tellers and sales-CEOs around.

But let’s recall what they did last year around the same time (fall 2020). They introduced a flurry of new products with focus on security. Now, a year after that the revenue remained at the same growth pace despite the security products. In a year from now we should see a strong acceleration from current rate in order to justify the valuation, I guess. That could happen or not. But example with security products (impact on revenue growth rate) is illustrative.

We have a consensus on the board that we follow the numbers. If numbers do not support investment thesis it becomes investment based on hope and not numbers. In my eyes Cloudflare is kind of in a gray zone. The bulls are not wrong because Cloudflare DOES INTRODUCE a lot of new products which could BRING THE NUMBERS in the P&L. But so far these products have not been reflected in any significant expansion of P&L and Cash Flow metrics.

I personally was not able to hold the position as the discrepancy between numbers and valuation became in my subjective judgement too large. But this view has been proven wrong by market so far. My reading of the market expectations is that next several quarters should show significant acceleration of fundamental metrics of the business. If this will not happen valuation will come down to “normalized” levels whatever that means. Unless Price will continue story telling and selling Cloudflare as future of internet and everyone will continue to believe that.

Best,
V

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If pricing/egress fee is the main lever for R2’s growth, NET has a heck of a problem. AWS, Azure & GCP can adjust pricing any time.

NET better leapfrog competition in terms of feature set.

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My $0.02, delivered $0.01 at a time:

  1. “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; $NET is the only player who is executing well.

  2. 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 MC is responding at this point to the emerging Story e.g. $NET will be a AWS-killer.

I myself think that $NET is essentially a Story Stock at this point, but considering 1) above, it’s probably still worth holding onto.

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We have a consensus on the board that we follow the numbers. If numbers do not support investment thesis it becomes investment based on hope and not numbers. In my eyes Cloudflare is kind of in a gray zone.

I am going to help with this thought process. A while back, I swear Saul was telling us he disliked all the free products. That NET was trying to get market share but not more money. That was the bell toll for my position.

There is a lot of support on the board for ‘where they might be’ in the future. But that doesn’t seem to ring true with follow the numbers. That is a hope story. Even if the CEO says they are going to be brilliant, our response should be to say ‘where are the numbers?’. There are plenty of good stories out there. I don’t see the growth in the numbers.

Also, yes, general enthusiasm can move stocks by 60%. Just look at Gamestop. That doesn’t meant the business is any better right now.

The price is nice for all of you holding, but I don’t see the business and I am starting to get lost in the jargon. (Another Saul warning sign.)

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There have been a flood of useful replies noting things that Cloudflare is doing that investors might be reacting to. Would anyone like to put them all together, summarizing them into one post? If so, that would be very nice.
Thanks in advance,
Saul

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Saul

I noticed that the stock has climbed since the announcement of R2. I didn’t pay a-lot of attention to the announcement until Corey Quinn (@QuinnyPig on Twitter) created a viral thread on the economic advantage of R2 to AWS S3. This was mentioned previously on this board.

Here is his blog post that builds on the thread - https://www.lastweekinaws.com/blog/the-compelling-economics-… . It is excellent in spelling out the various economic scenarios that make R2 a no brainer.

The quote from the end of the post that resonated with me, “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 Technology 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.

My 2 cents
Mac

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Saul-

Based on this post, I wonder why Cloudflare is even in your portfolio. You regularly emphasize that your approach is based on the numbers and not understanding the technology of a business. Your writings regularly emphasize that your ownership decisions are ruthlessly mercenary–if the numbers show you the hypergrowth, you own the thing. When the numbers don’t show it, you don’t own it.

I wonder why you post that you don’t have a thought about selling Cloudflare. If its numbers are so much worse than the “true Saul Stocks,” shouldn’t you have that thought?

Why must there be something real pushing up the price? Your post seems like a search for a story to rationalize holding the stock. I also think that your instincts regarding sentiments of the crowd and timing of trades are much better than you usually like to admit.

Hope this helps your thoughts on this one. All the best!

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What am I missing with Cloudflare: Summary of Posts 2021-11-01

In order of post, I have summarized and/or para-phrased the many responses. There is some repetition, so I only added a subsequent post if it added a different take. Apologies if I have missed or mis-stated anything. I have bolded what seem to be the main points.

GolfCaddy4PLynch: Will allow developers to lower the costs associated with data transfer on AWS S3. 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.

TheGriz: The collective confidence that Cloudflare is going to massively succeed.

brandonwahl: The Facebook outage happened on October 4th. Looking at the stock chart for Cloudflare, that’s the exact day it began its run up from 115 to where it stands today.

rodatl: (re NET being a major content delivery network)- CDN’s importance is increasing dramatically because the data transmitted and stored in the age of AI and Machine Learning is beyond ridiculous now.

nilvest: NET is getting benefit of CEO articulating vision of becoming that 4th hyperscalar / cloud / IaaS company (after AWS, MS Azure and GCP). Delivery R2 as first step to match that vision. Does not surprise that Reddit crowd may be getting on it as well.

cybergroth: dominance in regards to being a reverse proxy, a layer between a web server and the rest of the Internet, providing security and better performance.

CloudL: The market for public cloud is massive. It’s like Cloudflare just started a new company with minimal cost. Additional revenue from R2 storage.

Note: There are varying views about whether the cloud giants can or will cut data transfer prices to compete with Cloudflare.

My take: Many good points have been raised and it’s unlikely to me that any one point is responsible for this big rise in stock price. They probably all play a role and maybe the “collective confidence” comment best encapsulates what’s going on.

Roller

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