Updates: Cloudflare - The Three S-Curves (Pt.4) - 1Q24 Overview, SASE GTM Dynamics, & Valuation

Summary

• In the final part of the Cloudflare series we discuss the 1Q24 results and the lack of GAAP EBIT improvements that may become an issue for investors.
• We discuss the dynamics compelling Cloudflare to execute a new GTM strategy more conducive for enterprise network security.
• We provide a valuation with investor considerations, pointing out that while we think Cloudflare is trading in the fair value range, there is way more downside than upside potential.

1Q24 Overview

NET outperformed its 1Q24 guidance by notable margins. Revenue generated was $378.6m growing at 30.5% YoY, vs. guidance of $373m which would have equated to 28.5% YoY growth. Non-GAAP EBIT came in at $42.4m, a margin of 11.2%, vs. guidance of $34.5m, a margin of 9.2% ($34.5 / $373). FCF margin was 11%, maintaining the average over the past few quarters. Despite the beats, NET's stock dropped 13% on the 3rd May, the day following the ER, as investors got a little spooked about Prince's remarks about macro uncertainty.

As per usual, in Prince's opening statement, within the first 2 or 3 sentences, he always mentions how many net new large customers - those spending over $100k in ARR - have emerged (existing or new) on the Cloudflare platform. Additionally, among the number of deals that most CEOs announce during such quarterly earnings calls, the majority Prince picks out are the enterprise networking and NetSec wins. These observations clearly show his determination in proving to the world that NET is capable of becoming a large enterprise vendor, rubbing shoulders with the likes of Zscaler (ZS) and Palo Alto (PANW).

In 1Q24, NET gained 122 $100k+ ARR customers, taking the total to 2,878. For context, NET gained 206 $100k+ customers in 4Q23, 198 in 3Q23, 196 in 2Q23, and 114 in 1Q23.

The sequential dip in net new adds in the $100k cohort (122 in 1Q24 vs. 206 in 4Q23) does appear to be seasonal. Notwithstanding, to divert attention away from the sequentially lower $100k customer add, Prince pointed out that, on a TTM-basis, the number of $100k+, >$500k+, and >$1m+ customers has reached record levels.

Digging into our largest customers, we added a record number of net new customers year-over-year spending more than $100,000, $500,000 and $1 million on an annualized basis. We are successfully moving upmarket and becoming a larger and more strategic vendor to more and more of our customers.

Prince also informed analysts that the revenue contribution coming from large enterprises was 67%, increasing from 62% in the same period one year ago, which is something he hasn't pointed out in the last few quarters.

Perhaps we're trying to read between the lines too much here, because overall, NET's penetration into the enterprise segment appears to be improving. This corroborates with our own checks in regards to SASE adoption, as well as an analyst on the 1Q24 call mentioning that his checks indicate NET is gaining SASE momentum. This is further corroborated by recently improved positions in Gartner's Magic Quadrant for SSE and Forrester's Wave for Zero Trust. However, NET still has a long way to go before becoming a go-to enterprise networking and cybersecurity vendor for the channel ecosystem. Later we will discuss the dynamics involved as NET continues to transition.