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Cloudflare (NET): Latest IPO To Disappoint Investors

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The enterprise cloud space continues to expand as another player enters the public markets. Cloudflare NET just launched its IPO on September 13th for a share price of $15 or a $4.4 billion valuation. Like most IPOs this year, the price immediate jumped 20% with the first public trade being for $18. NET has traded up to $22 and down to $15.50 over the past 2.5 weeks.

The Business            

Cloudflare’s product offering leverages cloud technology to create an efficient internet for companies of tomorrow. It provides a scalable cloud network for enterprises that spans over 194 cities in 90 countries. The platform offers embedded security and performance as well as a breadth of functionality that allows customers to reduce the number of cloud services they need. Its product offering is a combination of security, performance, and reliability.

Cloudflare’s initial entices customers with its state of the art security software, which blocks 44 billion cyberattacks daily. Once the customer is satisfied with the platform’s performance they begin to add more of Cloudflare’s software.

Software like Cloudflare Argo which, “improves Internet performance by intelligently routing end users through the least congested and most reliable paths over the Internet using our network,” according to the firm’s prospectus. More than 70% of Cloudflare’s enterprise customers are utilizing at least four of its products.

Cloudflare continues to innovate and add more and more capabilities to its already extensive list of products. Its continued innovation will only further increase the attractiveness of the platform’s “one-stop-shop” offering for all a firm’s enterprise cloud needs. This cloud platform’s scalability makes it a perfect fit for any growing business.

The company’s customer retention and ability to meet evolving customer needs is impressive. Below is a chart from Cloudflare S-1 filing illustrating revenue and customer retention.

Over 20 million internet properties are currently using Cloudflare, making up 2 million paying and nonpaying customers. 10% of Fortune 1000 companies use this platform, including Walmart WMT, Adobe (ADBE - Free Report) , IBM IBM, and Zendesk ZEN.

The Financials

Cloudflare’s revenues have grown by a compounded annual growth rate (CAGR) of over 50% in the past 2 years, but its net loss has increased by almost 9 fold from 2017 to 2018. The topline appears to remain healthy, with the first six months of 2019 demonstrating 48% growth.

The gross margins for this enterprise are robust, sitting at over 77%, but it has yet to flow down to the bottom-line, which is still experiencing an increasing deficit.

It is very costly to expand a business as fast as Cloudflare has. Over half of the company’s 2019 operational expenses are coming from sales and marketing. R&D spending is growing as fast as Cloudflare’s topline, with innovation being a critical factor in the firm’s continued expansion.

Cloudflare’s net loss appears to have marginally improved in the first 6 months of 2019, but they have a long way to go before profitability.

Cloudflare is an international company with roughly 50% of its profits coming from outside the United States. This diversifies the firm’s revenues and broadens its total addressable market (TAM).

NET is trading at a TTM P/S of 21x, which is exceptionally high for the space compared to its competitors who are seeing P/S valuations below 10x. Cloudflare’s growth potential exceeds its competitors, but a multiple this high is still a very risky investment.

Take Away

Cloudflare became a unicorn back in 2012 and has today improved that valuation by roughly 5 fold. This company has a compelling product offering, but I do not expect that it will maintain its current price. I believe that this is another case of IPO mania overvaluing an exciting new company with an intriguing offering.

I discuss other 2019 IPOs and their disappointing shareholder returns in my article Peloton (PTON) Is The Latest Skid Mark In 2019's IPO Bonanza.

This stock is very volatile as investors and traders seek a reasonable valuation for this stock. I would wait for a few quarterly earnings releases to see if Cloudflare can maintain its growth while reducing its deficit.


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