Cloudflare’s IPO

September 8, 2019

Cloudflare’s IPO

Cloudflare is planning to list on the NYSE on September 12th 2019. It is a provider of cloud software solutions that span security (firewalls, bot management, DDoS, infrastructure protection, etc), performance (content delivery, intelligent routing, content optimization, etc), and reliability (load balancing, virtual backbone, DNS network and resolver, website caching), platform (serverless applications solutions) and other consumer offerings (DNS resolver and VPN solutions).  See Figure 1 form full product stack taken from the S-1.

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Figure 1: Cloudflare’s product stack

Phew, ok – that was a lot of technical jargon. The takeaway is that the company is a provider of cloud software solutions that enable customers to run online businesses and services designed for global scale. Cloudflare’s network spans 193 cities in over 90 countries with 8,000+ networks globally, and they stop about 44 billion cyber threats per day. Services are offered through the freemium model, where basic services are available for free, with the option to pay for additional services.

How do the numbers look?

The company is gaining leverage on its revenue. This means that revenue is growing at a faster rate than cost of revenue.  In the time frame shown below, Cloudflare’s revenue increased by 247%, while the cost of revenue increased 146%.

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Figure 2: Revenue growth is outpacing the growth of cost of revenue. From the company’s S-1

There are several reasons for this increased efficiency. First, the dollar-based net retention rate has averaged around 110% in the past 8 quarters. This means that existing customers who spent 1 dollar a year ago, would spend 1.1 dollar today. This is significant for Cloudlfare’s business, as the company does not have to spend sales and marketing dollars to acquire this revenue.   

Second, the data advantage. Cloudflare’s product gets better with more users and more data. They consider their application to be similar to an internet-wide immune system, where Cloudflare learns from all the traffic that flows through its network, and can therefore better mitigate and stop attacks carried out by bad actors, but also better optimize its products for good actors. 

And third, the company has established itself as the leader in this space and is making ground growing its “large customer” base (customers who spend more than US $100,000 per year with Cloudflare). This segment grew from 95 customers in December 31st 2016, to 313 in December 31st 2018 and 408 as of June 2019 -an increase of 70% year over year. Growth in this segment can increase efficiency as the total revenue generated per customer acquired is larger.

How does Cloudflare stack up against its competitors?

Given the wide range of products that Cloudflare provides, it faces competitors from multiple technology planes (other CDN provides, HW makers, point solution vendors). Due to differences in maturity, size, and business models, it is difficult to compare revenue of these competitors with Cloudflare. However, one metric we can use to compare the businesses across different verticals is the sales efficiency metric

Sales efficiency is calculated by comparing the amount of revenue gained to the amount spent on sales and marketing (in other words, how efficient the company’s sales efforts are in bringing more revenue. The higher the number, the more efficient). Figure 3 summarizes the average sale efficiency of different companies across the three technology planes over the past year. As you can see, Cloudflare comes out on top across the different planes, with an average of 0.74 (orange line) (Tweet this!).

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Figure 3: Sales Efficiency of Cloudflare vs. competitors. Sales efficiency = 4X(Current Quarter Revenue – Previous Quarter Revenue) / Previous Quarter Sales & Marketing (Tweet this!)

From this list, Fastly (FSLY), is probably the closest competitor to Cloudflare. But it is smaller in revenue (Q2 2019: US $46.17 million vs. Cloudflare’s US $67.4 million) and has slower year over year revenue growth (34% vs. Cloudflare’s 49%). 

Since Cloudflare is still not profitable, public investors will likely value the company based on its revenue growth, and therefore its sales efficiency number will be an important number to keep an eye on.

Thanks for reading!

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