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Small Cap Pick: Cloudflare (NET-US, $43B MCAP)

In a world increasingly shaped by AI, security threats, and distributed computing, one company is quietly positioning itself as the connective tissue of the modern internet: Cloudflare.

This isn’t your typical infrastructure provider. Cloudflare isn’t selling GPUs or hosting massive AI training clusters. Instead, it’s building the rails — the global, low-latency network that applications use to reach users, securely and instantly. As hyperscalers chase bigger training models and SaaS giants jostle for AI mindshare, Cloudflare is focused on delivering the foundation that allows all of it to work in real time, at scale.

In this report, we’ll go through Cloudflare’s evolving role in the tech stack, its bold push into AI inference, security, and edge development, and assess whether the stock offers compelling medium-term upside — or if it’s priced ahead of fundamentals. With a blowout Q1 2025 earnings last week and major product shifts underway, this is a pivotal moment to evaluate the company’s trajectory.

Let’s dive in.

• Why now? 👉 Key Player in AI Distribution

• Overview 👉 What Does Cloudflare Do?

• Product Suite 👉 CDN, Developer Cloud, Security

• AI & Hyperscaler Bypass 👉The New Platform Opportunity

• By The Numbers 👉 Key Metrics

• Risks 👉 Potential Pitfalls

Why now? 👉 Key Player in AI Distribution

Cloudflare has emerged as a critical enabler in the current AI boom, positioning its global network as an essential distribution layer for AI applications. In late 2023, Cloudflare made headlines by securing its largest contract ever (over $100 million), driven by a customer leveraging Cloudflare Workers – the company’s serverless platform – to deploy AI services at scale. This win underscores how Cloudflare’s network is becoming instrumental for companies rolling out AI-driven products. In fact, even OpenAI (the creator of ChatGPT) relies on Cloudflare’s security and network to handle surging traffic for its AI services. Simply put, as generative AI goes mainstream, Cloudflare is providing the pipes and delivery mechanism that help these models reach users quickly and securely.

Several trends are converging to make Cloudflare especially relevant now. The rise of edge computing means more processing is done closer to users – exactly Cloudflare’s domain with 275+ cities in its network. AI inference (running trained models to get results) benefits from this edge approach: Cloudflare’s CEO notes their network is “fifty milliseconds from almost everyone on Earth”, ideal for low-latency AI responses. At the same time, enterprises are seeking to bypass hyperscaler lock-in and high data egress fees. Cloudflare’s new platform capabilities (like its R2 storage with zero egress fees) appeal to companies wanting flexibility to move data and workloads across providers. In short, Cloudflare sits at the intersection of key medium-term themes – AI, edge computing, and multi-cloud networking – which is why the company is garnering attention as a potential winner in the next phase of internet infrastructure.

Overview 👉 What Does Cloudflare Do?

Cloudflare, Inc. is a cloud services company founded in 2010 with a mission to “help build a better Internet.” It began by offering a Content Delivery Network (CDN) and DDoS protection but has since evolved into one of the world’s largest distributed networks. Acting as a reverse proxy between users and web servers, Cloudflare filters attacks, caches content, and provides services like encryption, traffic optimization, and edge load balancing. It now secures and accelerates millions of websites and applications, blocking billions of threats daily.

Unlike traditional hosts or data centers, Cloudflare is an overlay network that operates across multiple layers of the internet stack: network (IP routing, attack prevention), application (web content, APIs, serverless apps), and identity/security (user and device verification). This position allows Cloudflare to complement providers like AWS or Azure, acting as a performance and security layer in front of them. Its vast peering and data center network enables faster, more secure global traffic delivery with reduced dependency on any single cloud provider.

Cloudflare monetizes primarily through a tiered subscription model, ranging from a popular free plan for individuals to enterprise-grade contracts. Usage-based charges also apply for services like bandwidth and Workers. This freemium strategy helps seed adoption while upselling businesses to higher-value plans. Today, 173 enterprise customers each spend over $1 million annually. Cloudflare’s broad customer base spans developers, SMBs, and large enterprises, all drawn by its promise of speed, security, and reliability delivered through a global edge network.

Product Suite 👉 CDN, Developer Cloud, Security

Cloudflare has evolved from a simple CDN into a full-edge cloud platform spanning performance, security, and developer tools.

Performance & Networking:
Cloudflare still offers its foundational CDN and Anycast DNS, but now also includes Argo Smart Routing for faster content delivery, Load Balancing, and Image/Video optimization. These services run from Cloudflare’s edge network, accelerating apps and websites for global users.

Security & Zero Trust:
Cloudflare built its name with DDoS mitigation and has since added a Web Application Firewall, Bot Management, and now Zero Trust services via Cloudflare One. Key offerings include Access (VPN alternative), Gateway (secure web filtering), and Magic Firewall/Magic WAN. These replace traditional security hardware with edge-delivered protection. A major Fortune 500 energy company’s 2022 adoption highlights Cloudflare’s enterprise traction.

Developer Platform (Serverless & Storage):
Workers, Cloudflare’s serverless compute platform, runs code globally at the edge for ultra-fast performance. It’s backed by tools like Workers KV (caching), Durable Objects (state), D1 (distributed SQL), and R2 (S3-compatible storage with no egress fees). Cloudflare also offers Pages (static sites) and Stream (video platform). Together, this stack allows full applications to run closer to users with fewer costs than traditional clouds. The recent $100M+ client win was driven by adoption of Workers and R2.

Unified Network Architecture:
Every Cloudflare server can deliver every service—security, compute, storage, or caching—offering consistency and scalability across 275+ cities. Unlike competitors with fragmented infrastructure, Cloudflare’s single global network is a key moat. It operates at the “edge” of the stack, between users and origin infrastructure, and increasingly replaces parts of the origin itself. Customers can front AWS or Azure backends with Cloudflare, achieving lower latency and tighter security while keeping backend flexibility.

In short, Cloudflare acts as a fast, secure, and programmable edge layer that integrates with or even replaces parts of centralized cloud platforms.

AI & Hyperscaler Bypass 👉The New Platform Opportunity

Cloudflare is carving out a unique position in the AI era by offering a “connectivity cloud” as an alternative to hyperscalers' “captivity clouds.” While it doesn’t focus on training AI models (which require centralized GPU clusters), Cloudflare is targeting AI inference—the phase where models are deployed and serve users. Its globally distributed network allows inference to run closer to users via Workers AI, reducing latency and enabling real-time applications like chatbots or AR features. This edge-based AI delivery is already attracting AI firms building inference engines directly on Cloudflare’s platform.

To support AI workloads, Cloudflare has rolled out tools like Vectorize (vector database for embeddings) and AI Gateway (to manage model access). It also offers R2, a hyperscaler-alternative for storage with zero egress fees. This solves a key pain point for AI companies shuffling massive datasets across clouds—now, a single copy can sit in R2 and be accessed anywhere without cost. Cloudflare positions itself as a neutral data layer, simplifying multi-cloud AI workflows while reducing costs.

Even if Cloudflare doesn’t host model training, its platform can handle pre/post-processing with Workers and serve results via its CDN. This positions Cloudflare as the connective tissue of AI pipelines and broader enterprise systems—its network links public clouds, edge compute, and on-prem infrastructure into a unified layer. The company’s role as a cloud-agnostic backbone extends beyond AI, offering enterprises a performant, secure way to interconnect services and route data.

Cloudflare’s broader vision isn’t to replace AWS or Azure but to unbundle the internet’s delivery layer: global distribution, low-latency compute, security, and open data access. With partnerships (like with Databricks or NVIDIA) and a modular, non-disruptive integration model, Cloudflare appeals to companies seeking speed, flexibility, and cost efficiency. Its “Connectivity Cloud” pitch reflects this ambition—to be the platform that sits between all others, optimizing and securing how the modern internet runs.

By The Numbers 👉 Key Metrics

Cloudflare remains in growth mode with ~27% YoY revenue gains, a moderation from 2021’s 50%+ pace but still strong amid macro IT headwinds. Management is optimistic, noting Q1 2025 brought in the highest net new contract value in three years. Large enterprise wins, like the recent $100M multi-year deal, reinforce sales execution at the top end of the market.

Gross margins (~75–78%) remain healthy for a network-heavy company, despite slight pressure from AI infrastructure investments. Operating margins and free cash flow are both positive, showing the business model is scaling efficiently without compromising growth. While GAAP profitability remains elusive (mainly due to stock-based comp), the trajectory is clearly improving.

Customer data shows a successful shift upmarket. While Cloudflare serves over 250,000 paying clients, it’s increasingly focused on larger ones. Customers spending over $100k rose 23% to 3,527 and now generate 69% of revenue, up from ~58% just a couple of years ago. $1M+ customers jumped 47%, reflecting product adoption and expansion. Net retention at 111% suggests growth from existing clients is strong, though not as explosive as during the pandemic peak. Still, it’s a level that supports healthy organic growth.

Sales execution is also improving. After addressing underperformance issues in 2023, Cloudflare saw a rebound in Q4 and Q1, driven by large deal wins and effective channel partnerships (e.g. in Zero Trust).

Looking ahead, Cloudflare’s management is targeting a $5B annual revenue run-rate by 2027. That would require ~30% annualized growth – aggressive, but not out of reach if product velocity and enterprise adoption stay on track. With financial discipline and expanding platform capabilities, Cloudflare is building a case for long-term growth beyond just CDN and security.

Risks 👉 Potential Pitfalls

• Growth Deceleration: High valuation leaves the stock vulnerable to slower-than-expected growth rates.

• Competition and Pricing Pressure: AWS, Zscaler, and Akamai pose substantial competitive threats, potentially forcing Cloudflare into price wars or increased spending on R&D and sales.

• Cybersecurity Threats: Any significant security breaches or prolonged network outages could harm Cloudflare’s reputation and customer trust.

• Overextension Risk: Rapid product expansion could dilute resources and risk product quality.

• Macro Environment Sensitivity: Cloudflare is susceptible to economic slowdowns and reduced IT spending, potentially impacting revenues.

• Regulatory and Geopolitical: Global operations expose Cloudflare to risks from geopolitical tensions, data sovereignty laws, and regional compliance complexities.

Wrapping Up…

Cloudflare’s fundamentals and growth trajectory are some of the best in the biz. They are operating in large and expanding markets (CDN, security, edge computing, AI infrastructure) and have shown they can consistently grow revenue ~25-30% with improving margins. It has a massive global network, a unified platform, and rapid innovation – that give it a shot at compounding growth for years.

However - it also trades ata price that requires confidence in that story. For a medium-term investor, it may be more prudent to look at opportunistic buying if you believe in the company’s edge in the AI and networking future.

As always, position sizing and time horizon are key – Cloudflare is best suited as a growth-oriented portion of a portfolio, with the understanding that there may be bumps on the road.

The company’s execution over the next few quarters (in landing big customers, expanding its AI/cloud offerings, and maintaining growth) will likely determine if NET’s stock can justify a stronger “Buy” conviction or if caution should prevail.

I believe we’ve got a winner here on our hands.

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Cheers,

The GRIT Alpha Team

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