Jim Tierney at AllianceBernstein recently told Yahoo Finance that chipmakers like Nvidia were the first phase of the artificial intelligence (AI) trade. He believes the next phase will focus on cloud computing and software companies that use AI chips to provide services to their customers. Tierney believes that phase will move into high gear in 2025.
Numerous companies should benefit as the trend takes shape, but Cloudflare (NET -1.78%) is one investors may overlook because it receives less media coverage than the "Magnificent Seven" companies. But Hamza Fodderwala and Keith Weiss at Morgan Stanley recently upgraded the stock and bumped the bull-case target price to $175 per share. From the current share price of $113, that implies monster upside of 55% in 2025.
Here's what investors should know about this cloud infrastructure stock.
Developers rate Cloudflare as the fourth-best cloud platform behind Amazon, Microsoft, and Google
Cloudflare is a cloud computing company that offers application, network, and security services. Its platform accelerates and protects IT infrastructure across on-premises, cloud, and hybrid environments. Cloudflare also has a developer platform that lets users build and deploy applications on its network, including AI applications.
The company has two important advantages in its speed and scale. Specifically, it operates the fastest cloud network on the planet, and it handles approximately 20% of all internet traffic. Unparalleled speed has helped Cloudflare secure leadership positions in the content delivery and edge development platforms markets. Speed also makes its infrastructure an ideal choice for AI companies.
Likewise, scale affords Cloudflare insight into performance problems and security threats across the internet. That data informs routing decisions and threat detection, creating a network effect that drives continuous improvement in network performance and security. Consequently, Cloudflare has become a major player in certain cybersecurity verticals, including email security and zero trust network access.
Here is the big picture: Cloudflare has a strong presence in the application, network, and security services markets. Indeed, a recent survey of 46,000 developers showed Cloudflare as the fourth-most popular cloud platform behind Amazon, Microsoft, and Alphabet's Google. And CEO Matthew Prince, during a recent CNBC interview, said 45% of Fortune 500 companies are Cloudflare customers.
In total, the company values its addressable market across those three product categories at $176 billion in 2024, but management expects that figure to reach $222 billion by 2027.
Image source: Getty Images.
Cloudflare powers 80% of the top 50 generative artificial intelligence products
Cloudflare reported solid financial results in the third quarter, beating estimates on the top and bottom lines. Its customer base increased 22%, the second consecutive acceleration, and the average existing customer spent 10% more. In turn, revenue increased 28% to $430 million, and non-GAAP (non-generally accepted accounting principles) net income increased 25% to $0.20 per diluted share. The company guided for 25% revenue growth in the fourth quarter.
Importantly, Cloudflare ranked No. 14 on the 2024 Fortune Future 50 list, an annual report done in collaboration with Boston Consulting Group. The report ranks companies based on their long-term growth prospects, and one reason Cloudflare placed so high is its popularity among AI start-ups. Nearly 80% of the top 50 generative AI web products rely on its network.
Additionally, Cloudflare has a potentially important partnership with Apple. Specifically, the company plays a behind-the-scenes role in Apple Intelligence by encrypting AI queries across hundreds of millions of devices, according to Morgan Stanley. If Apple Intelligence becomes a material source of revenue for Apple, it could also become a material source of revenue for Cloudflare.
Going forward, Wall Street estimates Cloudflare's adjusted earnings will grow at 36% annually through 2027. That makes the current valuation of 160 times adjusted earnings look very expensive. Investors comfortable paying a premium for what promises to be a volatile stock can buy a few shares. But it would be more prudent to wait for the price to fall at least 15%.
