Company Overview

Cloudflare, the leading cloud platform for network infrastructure, filed for an IPO last week ($100M placeholder). Goldman Sachs is leading the IPO and the company plans to trade under the ticker “NET” on the NYSE. Cloudflare offers a wide range of network services to 2 million free and paying customers across 20 million internet properties globally. Their product is a unified control plane that includes security, performance, and reliability — essentially all the network infrastructure a company would need to operate online in a cloud-first world. The company’s mission “is to help build a better Internet”. Cloudflare calls out the massive move to the cloud and the inability for legacy network approaches — such as a myriad of standalone “band-aid” hardware boxes — to effectively address the network needs of complex, heterogeneous (and cloud-first) infrastructure environments that exist today. The company says “there is literally no place to install such a box in the cloud.” Cloudflare has massive adoption of their products and while the vast majority of customers use their products for free, they had almost 75,000 paying customers (as of 30-Jun-2019) and did $129.2M in revenue in the first 6 months of 2019, up 48% YoY. The company was founded in July of 2009 and is based in San Francisco, CA. Cloudflare has 1,069 full-time employees.‍

‍Key milestone graphic from S-1:‍

‍Product Offerings

Cloudflare’s suite of products offers a unified control plane of network services for any company operating online and across any infrastructure environment. They have solutions that span security, performance, and reliability as well as consumer and platform offerings. Customers can sign up for free with one click. Cloudflare announces new products every September, dubbed “Birthday Week” to celebrate the company’s birthday. An overview of their product offerings is below:

• Security: an integrated cloud-based security platform designed to secure the public cloud, private cloud, on premise, SaaS applications, and IoT environments. Products span across firewalls, bot management, DDoS, infrastructure protection, zero-trust security, IoT, SSL/TLS, secure origin connections, and rate-limiting.
• Performance: solutions to help customers improve conversions, reduce churn, improve visitor experiences by increasing web and mobile application performance, as well as keeping them online. Products include content delivery, intelligent routing, content optimization, mobile optimization, image optimization, and a mobile SDK (software development kit).
• Reliability: products to improve customers’ operational excellence of the internet and includes load balancing, virtual backbone, DNS network and resolver, and website caching.
• Platform: Cloudflare offers a solution for developers so they can build serverless applications without needing to worry about network infrastructure or operations. It includes a serverless computing network for developers to augment and create applications in the Cloudflare execution environment, called Cloudflare Workers, as well as a product that allows developers to package Cloudflare Workers for their end customers, and an analytics/insights module to use across internet properties.
• Consumer Offerings: Cloudflare also offers consumer products to enable individuals to have a performant and secure internet experience. They include a public DNS resolver and Warp, which is a VPN for consumers.

‍Cloudflare Products Graphic‍

Cloudflare also discusses a “network” and “product” flywheel as core differentiators. Their network was designed to scale to serve the entire internet and to do this cost-effectively, they needed a new type of architecture. Cloudflare built a “serverless” network that can be deployed on commodity hardware and developers/customers don’t need to worry about the underlying infrastructure. And because Cloudflare can optimize performance, they utilize their idle capacity for their free tier.

Cloudflare also talks about their product flywheel; the company made its products easy to use and free (which they can offer because of their ability to utilize their idle network). They learn from the 20 million internet properties that use their products like an “immune system” to better protect customers and block on average ~44 billion cyber threats per day. Cloudflare also utilizes the feedback from this large customer base to improve the product experience. In Q4 of 2018 Cloudflare had an NPS of 68 across their paying customers. The company has also started to serve consumers, further enhancing this network effect. Cloudflare believes the combination of these factors have enabled them to reach — and maintain — their market leadership positioning.

‍Cloudflare Pricing (from website)

‍Summary Metrics and GTM (Go-to-Market)

Cloudflare, like many other recent SaaS IPOs, is growing their top line quickly — revenue for the first 6 months of 2019 was $129.2M, up 48% YoY. CY’2018 revenue was $192.7M, up 43% YoY. The company has also accelerated its year-over-year revenue growth rates in each of the last 4 quarters. Cloudflare’s revenue is mostly subscription in nature and they ended last quarter (30-Jun-2019) at $269.7M of implied ARR (total quarterly revenue * 4). As expected, they’re still losing money and in the first 6 months of 2019 had a (29)% and (27)% GAAP and non-GAAP operating margin, respectively. Cloudflare ended last quarter with 74,873 paying customers, up 33% YoY, and perhaps more importantly grew their $100K+ annual billings customers 70% YoY to a total of 408. Their implied ACV (annual contract value) was $3,602 (implied ARR/paying customers) last quarter. Cloudflare’s dollar-based net retention rate has been over 110% for the last 8 quarters and was at 111.3% in the most recent quarter. A few other relevant stats from the S-1 below:

• Cloudflare has over 20 million internet properties using their products and blocks ~44 billion cyber threats per day on average. Around 10% of the Fortune 1,000 are paying Cloudflare customers and across the broader internet, ~10% of the top million, 17% of the top 100,000, and 18% of the top 10,000 websites use at least one Cloudflare product on a paid or free basis. Cloudflare also has customers above $3M in annual billings.
• They operate within 100 milliseconds of 98% of the Internet-connected population in the developed world, and 93% of the Internet-connected population globally (for context, the blink of an eye is 300–400 milliseconds). Trillions of internet requests are routed through the Cloudflare network every month.
• Over 70% of Cloudflare’s enterprise customers already leverage four or more of their products.
• The company derived 52% of revenue from international customers for each of the years ended 2017 and 2018.
• Implementation for the products is quick. Most customers under their self-serve plans implement usage of Cloudflare products within a matter of minutes.
• The sales cycle for customers under Cloudflare’s Enterprise plan is typically less than one quarter.
• As of June 30, 2019, Cloudflare had over 100 issued patents and 60 pending patent applications in the United States and abroad.
• In the three months ended June 30, 2019, Cloudflare made offers to less than 1% of applicants and had an offer acceptance rate of 90%.
• Cloudflare does not sell user data nor does it compete with its customers.

Cloudflare has a multi-pronged go-to-market strategy. They offer a free and monthly subscription tier that is self-serve, as well as an enterprise tier and sell both direct and through channel partners. 91% of revenue in the past 6 months was from direct sales and 9% from channel sales. The vast majority of their paying customers utilize their self-serve tier, which is paid monthly on a credit card. Enterprise plans, which generally have contracts that range between 1 to 3 years and are billed monthly, are acquired through their inside and field sales force. The majority of revenue in 2018 and over the past 6 months was from enterprise customers that were acquired through inside and field sales teams. Pricing is primarily subscription-based and enterprise pricing includes subscription as well as usage-based pricing. Cloudflare is investing more in its direct sales force as that’s clearly where the business is seeing most of its revenue (and growth) and while they don’t report it, that segment likely has much better unit economics.

Market Opportunity

Cloudflare paints a broad and massive market opportunity given the breadth of their product suite. The company believes they operate in the following markets; VPN, internal and external firewalls, web security (including web application firewalls and content filtering), distributed denial of service (DDoS) prevention, intrusion detection and prevention, application delivery controls, content delivery networks, advanced threat prevention (ATP) and wide area network (WAN) technology.

According to IDC, those markets represented $31.6B of total spend in 2018 and is expected to grow to $47.1B by 2022, representing a 10.5% CAGR (compound annual growth rate). Lastly, they call out they’re developing products to address other markets in the compute, storage, 5G, and IoT markets that aren’t included in the above market sizing numbers.

Competition

Given the broad market, competition is obviously widespread across their products and Cloudflare buckets competition in the following areas 1) On-premise network hardware vendors such as Cisco, F5, Check Point, FireEye, Imperva, Palo Alto Networks, Juniper Networks, and Riverbed as primary competition 2) Point solution vendors across the cloud security market such as Zscaler, OpenDNS (Cisco), CDN vendors such as Akamai, Limelight, Fastly, Edgecast (Verizon), DNS services vendors such as Dyn (Oracle), Neustar, UltraDNS and cloud-based SD-WAN vendors as well as 3) some services provided by the major public cloud vendors including AWS, GCP, Azure and Alibaba.

Investors and Ownership

According to Pitchbook, Cloudflare has raised $404.3M from investors such as NEA, Union Square, Pelion, Venrock, CapitalG (Google Capital), Franklin Templeton, Microsoft, Greenspring, Fidelity, and others. 5%+ pre-offering institutional investor shareholders include NEA (23.0%), Pelion (20.9%) and Venrock (19.5%). Matthew Prince, co-founder and CEO, is at a 20.2% pre-offering ownership stake. According to Pitchbook, Franklin Templeton led their last round, which was a $150M series E in March of 2019 at a $3.1B pre-money valuation.

Financials and Metrics Outputs

As mentioned earlier, Cloudflare is growing their top line quickly as well as gaining some operating leverage. Revenue growth has been accelerating YoY for the past 4 quarters and gross margins are in the high 70’s. Given the growth in enterprise logos — $100K+ annualized billings customers grew 70% YoY last quarter — Cloudflare investing more into building the enterprise sales team is a good strategy. Their sales efficiency is fairly strong and their implied months to pay back, which is the inverse of a CAC ratio (net new implied ARR * gross margin/sales and marketing spend of the prior quarter), was at a median of 18 months over the past 9 quarters. The company does not release customer counts by quarter. Cloudflare has $124.7M of cash and marketable securities on their balance sheet and raised $404M from investors, implying they have burned through ~$280M of cash to get to $270M of implied ARR, which is quite good. Outputs of other metrics are below.‍

‍P&L & Metrics (000's)

‍Key Business Metrics and Non-GAAP Financial Measures Output ($M)

Quarterly Revenue ($M)

Implied Ending ARR ($M)

Cloudflare added $22.8M of implied net new ARR over the past quarter and $88.6M over the past year.

Quarterly non-GAAP Gross Margin and OpEx as a % of Revenue‍

Quarterly GAAP and Non-GAAP Operating Margins‍

Large Customer and Product Launch Growth

Cloudflare is investing in new products as well as larger enterprise customers. The output below shows the year of new product launches as well as $100K+ annualized billings customers, which grew 70% YoY to 408 in the most recent quarter.

‍Customer Cohorts and Dollar-Based Net Retention Rate

Cloudflare discloses the growth in annualized billings for cohorts of customers that first became paying customers from 2011–2018. As you can see below cohorts tend to expand over time. Note this excludes the Baidu agreement.‍

Cloudflare also discloses their dollar-based net retention rate, which compares the annualized billings from paid customers 12 months prior to the annualized billings from the same set of customers in the last month of the current period. It includes any expansion and is net of contraction and attrition, but excludes annualized billings from new customers in the current period. It has been above 110% for the past 8 quarters.

Revenue and Cost of Revenue Output

Cloudflare put the below graphic in their S-1, which is another view of their operating leverage. The company is growing revenue significantly faster than its cost of revenue. Between the three months ended March 31, 2016 and the three months ended June 30, 2019, Cloudflare’s revenue increased by 247% with a 146% increase in cost of revenue.

Network Coverage Output

Cloudflare’s network spans 193 cities in over 90 countries with 8,000+ networks globally.

Sales Efficiency and Payback Periods

Cloudflare doesn’t release customer counts by quarter, but the output below charts their implied months to payback using the inverse of a CAC ratio (net new implied ARR * gross margin/sales and marketing spend of the prior quarter). The magic number is defined as just net new implied ARR/sales and marketing spend of the prior quarter. I only looked at the past 6 quarters to normalize for the Baidu seasonality in the chart below. The median months to pay back over the past 9 quarters was 18 months using the CAC ratio.

Cash Flows ($M)

‍Quarterly P&L / Metrics (000's)

‍Valuation

Given Cloudflare does not have profits, they will be valued on a multiple of forward revenue, similar to other high-growth SaaS companies. To illustrate the valuation ranges for the upcoming IPO, the output below uses NTM (next-twelve-months) revenue based on an illustrative range of growth rates and comparable EV (enterprise value)/NTM revenue multiples from other public, high-growth SaaS businesses. It also includes an implied ARR multiple range. Note that companies do not release forward estimates or guidance in their S-1’s. While the markets have been volatile over the past few weeks, the fastest-growing software companies are still trading at elevated multiples — CrowdStrike (CRWD) and Zoom (ZM) are trading at 44x and 41x EV/NTM revenue, respectively, although both are growing revenue 100%+ YoY (as of 20-Aug-2019). Fastly (FSLY), the closest competitor to Cloudflare, is trading at an 8x EV/NTM revenue multiple and is growing ~30% YoY (as of 20-Aug-2019). Given Cloudflare’s revenue growth and leadership position, I suspect they trade at a higher multiple than Fastly and a fair amount higher than their last private round valuation of $3.1B.

Cloudflare Illustrative Valuation Ranges‍

Cloudflare is the leading cloud-first CDN and network services provider and has major trends moving in their favor — the move to cloud infrastructure and the increased need for secure and performant applications/websites. They also have a fairly efficient business and are ~40% bigger (and growing slightly faster) than their nearest competitor, Fastly, on an LTM-revenue basis. I suspect the public markets will look past the operating losses given their revenue growth, market leadership, and fairly efficient, self-serve model. Similar to essentially all the previous high-growth SaaS IPOs over the past few years, Cloudflare should fare well in the public markets.

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