When Cloudflare (NYSE:NET) posted strong growth in the third quarter and issued its fourth-quarter outlook, NET stock struggled to break out above the $205 – $220 level.
The Nasdaq’s slump in November held CloudFlare back.
Now that negative market sentiment potentially accelerating, technology stocks at unfavorable valuations will fall. This gives investors who missed the recent run-up on Cloudflare an opportunity to start a long-term position.
Investors cannot time the ending of the technology stock correction. Therefore, as markets shy away from Cloudflare on valuations, patient investors should look at its quarterly results again.
CloudFlare posted revenue growing by 51% to $172.3 million. It added around 170 large customers in the period. It now has 1,260 large customers.
Cloudflare posted a net loss of $107.3 million, though it noted a non-GAAP net income of break-even.
Speculators are willing to buy companies that posted no profit in good times. When panic and caution dominate the markets, the lack of income is a concern.
A Closer Look at NET Stock
While a company like Palantir Technologies (NYSE:PLTR) can report small contract wins, as measured by revenue, Cloudflare’s potential grows after the large company business wins.
Directionally, the business’s cloud solutions are attracting larger customers over time.
Cloudflare launched many products and has good attach rates with existing customers. This means that customers want to buy more of Cloudflare’s solutions.
New customers are finding out about the company at greater rates. The software company built a sales team that is building relationships with larger companies.
Last year, the Covid-19 lockdown forced companies to re-think their IT needs. Companies embraced online solutions as the shutdowns continued. Now that people are returning to work physically, companies continue to require cloud solutions. For example, they need databases, cloud providers, and Cloudflare’s R2 solution.
Co-Founder and Chief Executive Officer Matthew Prince said that the company thinks R2 is very disruptive in the market. It will let Cloudflare not only capture more of the object store spending, minus the egress fees.
The CEO thinks its competitors are charging too much markup for data fees. It wants to offer the same solution at a fraction of the cost. By helping its customers save money, Cloudflare’s market share will grow. It will capture a bigger percentage of its addressable market in a shorter timeframe.
Investors should take advantage of Cloudflare’s stock weakness as a chance to start a long position. Wall Street analysts offer a mixed view.
Six analysts rate the stock as a buy and nine rate NET shares as a hold (per Tipranks). The price target ranges from $117 to as high as $250.
Risks and Fair Value
Cloudflare and software stocks generally risk a valuation correction. Investors may mitigate this risk by waiting for the share price to fall further.
This year, investors lost money holding Chinese internet stocks or cryptocurrency stocks if they bought at the peak. They may sell NET shares to realize capital gains before the end of this year.
A slowdown in the manufacturing sector could hurt demand for Cloudflare’s software.
For example, its Magic Transit is a winning product. Manufacturing and pharmaceutical companies need it to accelerate web traffic and to protect against DDoS (distributed denial of service hacking attack). Cloudflare may circumvent this risk by encouraging customers to continue using Magic Transit and its other products.
Cloudflare still trades at an unfavorable valuation. The stock’s fair value is up to $145.79, assuming revenue grows at 50% annually until the fiscal year 2025. It trades today closer to $140.
| Metrics | Range | Conclusion |
| Discount Rate | 7.0% – 6.0% | 6.70% |
| Terminal EBITDA Multiple | 67.5x – 69.5x | 68.5x |
| Fair Value | $136.58 – $145.79 | $140.07 |
The discounted cash flow EBITDA exit model shown above uses an EBITDA Exit multiple to calculate Terminal Value after five years.
The model set a generous 68.5 times terminal EBITDA multiple. Furthermore, the calculation assumes that interest rates will remain low.
The Federal Reserve did not indicate it will raise interest rates immediately. This may give Cloudflare a few quarters to post accelerating revenue growth.
Your Takeaway
Software technology stocks often trade at stock price-to-earnings multiples that are above the market average. Investors may bet on the company posting strong results in February 2022. With three months to go, the stock could fall low enough to encourage investors to start a position in this fast-growing company.
On the date of publication, Chris Lau did not have (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.
Chris Lau is a contributing author for InvestorPlace.com and numerous other financial sites. Chris has over 20 years of investing experience in the stock market and runs the Do-It-Yourself Value Investing Marketplace on Seeking Alpha. He shares his stock picks so readers get original insight that helps improve investment returns.