Cloudflare Earnings: Strong Execution in a Tough Macroenvironment Makes for a Solid Quarter

We are maintaining our $60 fair value estimate for narrow-moat Cloudflare NET after the firm reported strong third-quarter results and guidance mostly in line with our expectations. Earlier this year, the company highlighted sales execution challenges that had hampered its financial results and guidance. Since then, we believe that it has rebounded, posting strong top-line growth and improved profitability against a tough macro backdrop while working to improve its sales personnel challenges. We view the shares as fairly valued, trading in 3-star territory.

Cloudflare’s top line for the third quarter clocked in at $336 million, up 32% year over year and 9% sequentially. Driving some of this growth was a 34% increase in large customers, defined as those spending more than $100,000. Cloudflare added 206 new large customers, the highest number in five quarters. The company also added a record number of customers with annual spending of $500,000 and $1,000,000 or more.

We attribute the strong customer additions to a revamped sales team, which had faced execution challenges earlier this year. Management highlighted a 60% increase in the pipeline generated by the new salespeople compared with the underperforming salespeople whom they replaced. We see these metrics as evidence that the company is taking the right steps to improve its execution, which we see as even more important during this period of macro uncertainty.

Cloudflare expanded adjusted operating margin to 12.7%, up 690 basis points year over year. We see a rapid margin increase as evidence of the company’s strong unit economics as well as operational discipline. Over the long term, we forecast robust margin expansion as the business scales up and is able to distribute costs over a larger revenue base.