Cloudflare‘s Q1 2022 earnings report was a tour de force, showcasing the company‘s unrivaled innovation engine, efficient business model, and massive market opportunity. The edge computing pioneer delivered revenue of $212 million in the quarter, up 54% year-over-year, while also driving significant margin expansion and achieving GAAP profitability. Cloudflare‘s pristine balance sheet, $1.7 billion in cash and short-term investments, and consistently strong free cash flow generation give it ample dry powder to continue investing aggressively for growth.
Enterprise Sales Engine Firing on All Cylinders
Cloudflare‘s enterprise go-to-market machine kicked into overdrive in Q1, landing a record number of high-value deals while maintaining best-in-class efficiency. Key customer wins included:
- A Fortune 500 healthcare company purchasing a 3-year, $1.2 million zero trust networking deal
- A Midwestern state government buying 75,000 zero trust seats for $5.1 million over 3 years
- A European auto manufacturer utilizing Cloudflare‘s IoT solution for $320,000 annually to manage 10 million+ connected vehicles
- A Fortune 1000 gaming company moving to Cloudflare‘s WAF and DDoS mitigation for $3.3 million over 3 years
Cloudflare now has 1,537 large customers spending over $100,000 annually, up 53% year-over-year. Even more impressively, customers spending over $500,000 and $1 million annually grew 68% and 72% respectively. With 12 $5 million+ customers and partners, Cloudflare is proving it can land true whale-sized deals. However, the company remains highly diversified, with no customer accounting for more than 5% of revenue.
Cloudflare‘s traction in key verticals like federal government, e-commerce, and financial services is particularly noteworthy. The company is "in the very final stages" of FedRAMP certification according to CEO Matthew Prince, unlocking a huge $100 billion+ market opportunity. Legislation like the $1 trillion U.S. infrastructure bill and President Biden‘s executive order mandating zero trust for federal agencies could provide massive tailwinds for Cloudflare‘s public sector business in the coming years.
Product Innovation in Overdrive
Cloudflare‘s pace of product innovation is simply unmatched in the industry. The company released 71 new products and 231 new features in Q1 alone. While legacy CDNs are struggling just to keep their aging networks running, Cloudflare is lapping them with cutting-edge offerings like:
- Area 1 Security: Cloudflare plug one of the only remaining holes in its zero trust platform with the $162 million acquisition of this next-gen email security provider. Area 1 utilizes AI and data analytics to proactively block phishing attacks and BEC at the network edge.
- R2 Object Storage: Entering open beta in May, R2 takes direct aim at Amazon S3 with zero egress fees and automatic migration. Storage has been one of AWS‘s biggest cash cows and Cloudflare is now poised to massively disrupt it.
- Workers Analytics Engine: Currently in closed beta, this product will give enterprises unprecedented visibility and troubleshooting capabilities for applications running on Cloudflare Workers. Expected to be a key growth driver for the Workers business.
- D1 SQL Database: Cloudflare‘s first foray into the database market leverages its global network to provide an "edge-native" SQL option for web developers. Still in closed beta but could be a major unlock for Cloudflare‘s developer platform ambitions.
With over 70% of its engineering organization focused on building new products vs. just 30% focused on existing offerings, Cloudflare‘s innovation lead on the competition should only widen over time. And the company‘s highly integrated, security-first architecture means each new product makes the overall platform more robust and sticky. As Prince highlighted, "the power of Cloudflare is that we‘re the unified control plane that can do it all."
While Cloudflare is best known for its infrastructure and security solutions, the company has quietly built one of the most powerful developer platforms in the market. The centerpiece is Cloudflare Workers, a serverless compute environment that allows developers to run code across Cloudflare‘s global network without managing infrastructure.
In Q1, Cloudflare saw several major developer-driven deals powered by Workers and the platform‘s unmatched performance, scalability, and ease of use:
- A large social network signed a $3 million deal to power a real-time messaging service on Workers and Durable Objects
- An Australian software company adopted Workers for $145,000 to enable real-time collaboration
- A Fortune 500 financial services firm went "all-in" on Workers and the Cloudflare developer platform with a $1.5 million deal
At its May Speed Week event, Cloudflare is expected to release a slew of new Workers features and supporting services to make the platform even more powerful. These include analytics and monitoring tools, a revamped developer docs site, and deeper integrations with third-party frameworks and APIs. As more workloads shift to the edge, Cloudflare is well positioned to capture developer mindshare and emerge as the destination of choice for building modern applications.
Expanding Internationally
Cloudflare continues to extend its network and customer base globally, with international markets representing a key growth vector. In Q1, international revenue grew 57% year-over-year, outpacing overall growth. EMEA had an especially strong quarter, growing 57% to represent over 26% of total revenue.
The one soft spot geographically was APAC, which decelerated to 31% growth year-over-year (vs. 70%+ growth the last 2 quarters). Management attributed this primarily to "tough compares and some COVID impacts." However, Cloudflare continues to invest heavily in the region, recently launching a new regional HQ in Singapore and achieving FedRAMP equivalent in Australia. Partnerships with leading Asian tech companies like JD Cloud and Samsung also provide a solid foundation for long-term growth.
Cloudflare‘s efficient and repeatable go-to-market playbook has allowed it to rapidly gain market share outside its home US market. The company now serves over 154,000 paying customers spanning more than 175 countries. And with over 270 cities in its global network and growing, Cloudflare has a significant competitive moat against legacy vendors when it comes to serving the needs of multinational enterprises.
Future Growth & Margin Expansion Opportunities
Looking ahead, Cloudflare‘s current $212 million revenue run-rate is a drop in the bucket compared to its massive $100 billion total addressable market. The company‘s expansion into new product categories like zero trust, edge computing, storage, and database open up tremendous white space for growth in the coming years.
There are also several underappreciated monetization opportunities in Cloudflare‘s business that could drive upside to estimates:
Cloudflare for Offices: This initiative to provide secure, high-speed connectivity to office buildings is still in early innings but has the potential to boost ARPU for Cloudflare‘s core products. There could also be future opportunities to monetize via revenue-sharing agreements with landlords and ISPs.
Consumer Apps: Cloudflare‘s WARP consumer VPN and 1.1.1.1 DNS resolver are currently free and used mainly as testing grounds for the company‘s enterprise security products. However, management has hinted at potentially introducing premium consumer subscription tiers down the line to monetize this massive audience.
Partnerships & Marketplaces: Cloudflare has built a budding ecosystem of partners around its platform, including major SaaS companies, cloud platforms, and managed service providers. Creating more formal channel programs and revenue-sharing models for this ecosystem could meaningfully expand Cloudflare‘s GTM leverage and deal sizes.
While revenue growth remains the top priority, Cloudflare also has significant room for margin expansion long-term. In Q1, the company achieved a record 79% non-GAAP gross margin and 2% operating margin. As Cloudflare benefits from greater economies of scale and higher-margin software products become a larger mix of revenue, margins should steadily ramp towards management‘s long-term targets of 75-77% gross margin and 20%+ operating margin.
Risks & Challenges
Despite Cloudflare‘s exceptional business fundamentals and massive market opportunity, the company does face some notable risks and challenges:
Macroeconomic Uncertainty: With interest rates rising, geopolitical turmoil escalating, and recession fears mounting, enterprise IT spending could slow materially. While Cloudflare is relatively insulated given the mission-critical nature of its services, it is not immune to macro headwinds.
Increased Competition: As cloud giants like Amazon, Microsoft, and Google invest more heavily in edge computing and security, Cloudflare could face stiffer competition for enterprise wallet share. Legacy CDNs and security vendors are also increasingly bundling their offerings and cutting prices to defend their market positions.
Open-Source & Privacy Challenges: With its Workers platform heavily leveraging open-source standards, Cloudflare‘s developer ecosystem strategy relies on these projects continuing to grow and maintain their permissive licenses. The company‘s massive trove of networking data could also come under increased regulatory scrutiny, particularly in privacy-sensitive geos like EMEA.
Valuation Concerns: Trading at 27x forward revenue, Cloudflare‘s growth-y valuation leaves little room for error. Any meaningful deceleration in top-line growth or profitability could lead to multiple compression and downside volatility. However, great companies tend to grow into their premium valuations over time.
While these risks shouldn‘t be taken lightly, Cloudflare‘s innovative culture, product leadership, developer mindshare, and experienced management team inspire tremendous confidence in the company‘s ability to navigate potential speed bumps and realize its immense long-term potential.
Conclusion
In a world where the Internet is becoming the new corporate network and cyberattacks are a constant threat, Cloudflare‘s mission to "help build a better Internet" has never been more critical. The company‘s global cloud platform is powering a new era of faster, safer connectivity for organizations of all sizes. With its leading scale, pace of innovation, and efficient business model, Cloudflare is exceptionally well-positioned to disrupt the networking, security, and application delivery markets for years to come.
Bulls will argue that Cloudflare is a generational company still in the early innings of penetrating its $100 billion total addressable market. With multiple product and GTM levers to drive durable 30%+ revenue growth and steady margin expansion, the company has all the ingredients to deliver tremendous value for shareholders. If Cloudflare can sustain its current trajectory, the stock has the potential to be a multi-bagger even from today‘s seemingly lofty valuation.
Of course, no investment is without risks and Cloudflare has its fair share, from intensifying competition to macro headwinds to open-source dependencies. However, betting against this team of ambitious, brilliant "geeks" focused on winning customers‘ trust above all else has historically been a losing proposition. As more and more IT workloads shift to the edge and the cybersecurity threat landscape grows ever more ominous, expect Cloudflare‘s disruptive vision for a faster, safer Internet to continue propelling its business to new heights.
