Shares of Cloudflare (NET) have surged by 30% since the company reported robust results for the second consecutive quarter in early November. With the cloud platform provider’s core business now stabilized after a turbulent start to the year, investors are turning their attention to the long-term potential for AI monetization.
Currently trading at \(73.95, Cloudflare’s shares had dropped to a low of \)39.90 in early May following a Q1 revenue miss and a weaker-than-expected outlook for the June quarter. Factors contributing to this downturn included extended sales cycles, irregular linearity, and a notable decline in deal closure rates.
However, Cloudflare rebounded during the summer tech rally, reaching a new 52-week high of \(76.07 in mid-July. By early August, the company showed signs of recovery, posting a 32% increase in Q2 total revenue to \)308.5 million, surpassing the consensus estimate by 1%. Sales execution improved significantly, culminating in a record quarter for new annual contract value (ACV) bookings.
Leading up to the Q3 earnings release at the beginning of this month, Cloudflare’s stock had retreated to the mid-\(50s. Following the positive surprise in the September quarter results, the stock soared by 13.8% in a single session. Total revenue grew by 32% to \)335.6 million, exceeding the consensus by 1.5%. Earnings per share of 16 cents surpassed the consensus by six cents, while gross margin expanded to 78.7%, up 100 basis points sequentially. Free cash flow margin also improved to 10% from 6% in Q2.
The operating environment in the latest quarter remained favorable overall, with stable pipeline close rates, consistent sales force productivity, and linearity comparable to the previous quarter. The total customer base grew by 17% to 182,027, and the dollar-based net retention rate increased to 116% from 115% in Q2, indicating steady follow-on business with existing customers.
Cloudflare onboarded 206 new customers in Q3 with annual spending exceeding \(100k, bringing the total number of large accounts to 2,558, a 34% year-over-year increase. Large customers now contribute 65% of total revenue. The company excelled in attracting net new customers with annual spending exceeding \)500k and $1 million, with over 30% of the Fortune 1000 as paying customers, leaving room for further growth in this segment.
The Q3 earnings call primarily highlighted Cloudflare’s advancements in AI. The launch of Workers AI in September introduced a serverless platform for scaling and deploying AI models, focusing on inference as a key AI opportunity. Workers AI enables developers to conduct inference efficiently without managing infrastructure, positioning Cloudflare to leverage the growing demand for AI processing.
Cloudflare’s strategy involves deploying GPUs across its global cloud network to facilitate AI inference tasks, aiming to have inference-optimized GPUs in 100 cities by the end of 2023. The company offers various avenues for AI monetization, including charging for inference services and integrating AI protection within its core security offerings.
In a strategic shift earlier this year, Cloudflare revamped its go-to-market approach under new chief revenue officer Mark Boroditsky, streamlining its sales team by removing over 100 underperforming sales representatives. Despite initial concerns about potential disruptions, the transition appears to have yielded positive results, with new sales team members exceeding activity targets and outperforming their predecessors.
Looking ahead, Cloudflare’s AI monetization prospects are poised to expand further, supported by innovative products like Vectorize and R2 object storage that cater to developers building AI applications within the Cloudflare ecosystem. With a focus on driving sales effectiveness and harnessing AI opportunities, Cloudflare is well-positioned for sustained growth and market leadership.
