Internet security and content delivery network Cloudflare (NYSE:NET) reported Q3 FY2021 results beating Wall St's expectations, with revenue up 50.9% year on year to $172.3 million. Guidance for next quarter's revenue was surprisingly good, being $184.5 million at the midpoint, 4.94% above what analysts were expecting. Cloudflare made a GAAP loss of $107.3 million, down on its loss of $26.4 million, in the same quarter last year.
Cloudflare (NET) Q3 FY2021 Highlights:
- Revenue: $172.3 million vs analyst estimates of $165.6 million (4.04% beat)
- EPS (non-GAAP): $0 vs analyst estimates of -$0.04 ($0.04 beat)
- Revenue guidance for Q4 2021 is $184.5 million at the midpoint, above analyst estimates of $175.7 million
- Free cash flow was negative $39.7 million, compared to negative free cash flow of -$9.78 million in previous quarter
- Gross Margin (GAAP): 78.2%, up from 76.3% same quarter last year
Founded by two grad students of Harvard Business School, Cloudflare (NYSE:NET) is a software as a service platform that helps improve security, reliability and loading times of internet applications and websites.
Cloudflare runs a large network of data centres around the world that serve as storage for their customers' content, shielding it from malicious attacks and delivering it in the fastest way possible.
The power of the product is in its size, used by tens of millions of internet properties, it is so big that it can protect customers even against state-sponsored attacks. And the massive volume of data flowing through the network allows their machine learning algorithms to improve every day.
The demand for Cloudflare is being driven by the massive technological shift from on-premise hardware to services in the cloud. Because almost any online business that is based in the cloud can benefit from Cloudflare’s services, the company is well positioned for the ongoing transformation.
Cloudflare competes in the market for network and content delivery services with companies like AKAMAI (NASDAQ:AKAM) or Fastly (NYSE:FSLY) and partly with cloud cybersecurity and vendors like Zscaler (NASDAQ:ZS).
As you can see below, Cloudflare's revenue growth has been exceptional over the last year, growing from quarterly revenue of $114.1 million, to $172.3 million.
This was another standout quarter with the revenue up a splendid 50.9% year on year. On top of that, revenue increased $19.9 million quarter on quarter, a very strong improvement on the $14.3 million increase in Q2 2021, and a sign of re-acceleration of growth, which is very nice to see indeed.
Analysts covering the company are expecting the revenues to grow 34.2% over the next twelve months, although estimates are likely to change post earnings.
What makes the software as a service business so attractive is that once the software is developed, it typically shouldn't cost much to provide it as an ongoing service to customers. Cloudflare's gross profit margin, an important metric measuring how much money there is left after paying for servers, licenses, technical support and other necessary running expenses was at 78.2% in Q3.
That means that for every $1 in revenue the company had $0.78 left to spend on developing new products, marketing & sales and the general administrative overhead. Significantly up from the last quarter, this is a good gross margin that allows companies like Cloudflare to fund large investments in product and sales during periods of rapid growth and be profitable when they reach maturity.
Key Takeaways from Cloudflare's Q3 Results
Since it has still been burning cash over the last twelve months it is worth keeping an eye on Cloudflare’s balance sheet, but we note that with a market capitalization of $62.8 billion and more than $1.81 billion in cash, the company has the capacity to continue to prioritise growth over profitability.
We were impressed by the exceptional revenue growth Cloudflare delivered this quarter. And we were also glad that the revenue guidance for the next quarter exceeded analysts' expectations. Zooming out, we think this was a fantastic quarter that should have shareholders cheering. The company is up 5.64% on the results and currently trades at $212.45 per share.
Is Now The Time?
Cloudflare may have had a good quarter, but investors should also consider its valuation and business qualities, when assessing the investment opportunity. We think Cloudflare is a good business. We would expect growth rates to moderate from here, but its revenue growth has been exceptional, over the last two years. And while its cash burn raises the question if it can sustainably maintain its growth, the good news is its very efficient customer acquisition hints at the potential for strong profitability, and its strong gross margins suggest it can operate profitably and sustainably.
Cloudflare's price to sales ratio based on the next twelve months of 80.3x indicates that the market is certainly optimistic about its growth prospects. There are definitely things to like about Cloudflare and there's no doubt it is a bit of a market darling, at least for some. But when considering the company against the backdrop of the tech stock landscape, it seems that there is a lot of optimism already priced in and we are wondering whether there might be better opportunities elsewhere right now.
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