Cloudflare Shares Rebound Sharply Following Post-Earnings Plunge
The stock has jumped 77% from the May 4 low of $39.90.
Cloudflare (NET, $70.64) shares have rebounded 77% from the May 4 low of $39.90. On Friday, the stock rose for the seventh session in a row—it’s now up 18.5% since Cloudflare in late April reported disappointing Q1 results. The latest enterprise value stands at 18 times the 2023 consensus revenue estimate of $1.28 billion.
Sentiment was a lot more negative after the March quarter results were released. The stock plunged 21% in one session. While Q1 total revenue of $290.2 million rose 37%, it missed the consensus estimate. Dollar-based retention fell to 117% from 122% in the previous quarter. To make matters worse, Cloudflare’s Q2 revenue guide of $305 million to $306 million (representing growth of 30%) fell short of the consensus of $319.8 million.
The company was forced to reduce its 2023 top-line outlook. For the year, it now sees total revenue of $1.28 billion to $1.284 billion (growth of 31% to 32%), down 4% at the midpoint from the prior guide and below the consensus at the time of $1.33 billion. The only good news was a measurable boost in the 2023 EPS outlook.
Cloudflare’s intelligent cloud network forms the core of the business. The company’s networking solutions help connect, secure and accelerate networks. Cloudflare’s SASE platform and Zero Trust security solutions are the main growth drivers (and what investors are really focused on right now). Cloudflare Workers, the company’s serverless cloud platform, is said to be the “third act” because it’s still gaining traction (now used by about 15% of all customers).
Cloudflare sports a total customer base of 168,159, up 13% year over year. It counts 30% of the Fortune 1000 as customers. There are now 2,156 customers with total ARR above $100k, up 40% from the year-ago level; these large accounts represent more than 60% of Cloudflare’s total revenue. Given the tough macro in Q1, Cloudflare added only 114 of these large customers (down from +134 in Q4), the lowest number in two years.
On the Q1 earnings call, Cloudflare CEO Matthew Prince said there was a “material lengthening” of sales cycles in the March quarter and a “significant decline” in deal close rates. The average deal cycle was 27% longer than the previous four-quarter average, while expansion deal cycles were nearly 50% longer. Linearity was poor, as the quarter was very back-end loaded. In fact, almost half of all new business closed in the final two weeks of the quarter.
In an interesting twist, Prince tried to place some blame for the poor showing in the March quarter on a group of underperforming sales reps. On the call, he said Cloudflare was really only limited by its go-to-market performance, which is fixable. In a clear marketing flex, Prince said Cloudflare is committed to turning the current macro headwinds into a catalyst for positive change.
With the recent addition of Mark Boroditsky as chief revenue office, Cloudflare has been “retooling” its go-to-market. In the process, more than 100 sales reps have been singled out for consistently missing expectations. These 100+ people, who are being “rotated out” of the company, contributed only about 4% of annualized business over the past year.
On the positive front, the top 15% of sellers on average have achieved 129% of quota over the past four quarters. Noting that about 27% of these top sellers started at Cloudflare in just the past 18 months, Prince said this shows that hiring the right people can lead to quick results.
Of course, hiring qualified sales talent and rapidly getting them up to speed in a difficult macro is a lot easier said than done. But the company is committed to replacing underperforming reps. Prince said he is “optimistic” that the sales team can be upgraded without “significantly” impacting sales capacity.
Traders were not too impressed given the disruption often caused by sale force changes. It should not be surprising that most Wall Street analysts were rather skeptical about the company’s ability to quickly turn things around, especially because management said it looks for macro headwinds to persist throughout this year.
But it’s not all negative for Cloudflare. The company’s Q1 new business pipeline growth remained strong, exceeding the internal plan. The Area 1 email security product has upside, while R2 object storage now has 33,000 paying customers that are storing more than 7 petabytes of data, up 25% sequentially in the March quarter. Business from AI-first companies jumped 20%+ sequentially. Cloudflare has plenty of long-term potential as an AI infrastructure provider.