Cloudflare’s stock rose 20% in the days following Q4 earnings with strong momentum for its Workers AI platform and accelerations in multiple key metrics, paving the way for the stock to potentially reaccelerate revenue growth while driving a shift to GAAP profitability. Management also expressed a high degree of optimism for AI inference and growth opportunities through 2025, especially for its Workers AI platform.

I break down the growth in the most important key metrics, Workers AI momentum, and commentary about AI opportunities below.

Workers Developers Grew from 2 Million to 3 Million in 2024

Cloudflare has quietly amassed a large developer base with tens of millions of developers, allowing for a rather frictionless ramp for its Workers AI platform, with 2024 seeing the platform record more than 50% growth. Workers AI positions Cloudflare to capitalize on the growing AI inference market via its unique approach that offers performance at or exceeding hyperscalers’ at a lower cost.

In Q4, management noted that active Workers developers crossed 3 million, marking a 50% growth from 2 million active developers in Q1 and 25% growth from 2.4 million developers in Q2. Since November 2023, active Workers developers have risen more than 200%.

The Workers platform essentially is Cloudflare’s moat, and what separates it from the rest of software in terms of what it can provide for AI. With Workers, Cloudflare eliminates cold starts, allowing code to be executed the moment it is received – we had explained to our premium members in 2023 that it is a “combination of competing with the hyperscalers, delivering app performance at faster speeds -- while keeping prices low --- that is unique to Cloudflare,” and what will help the platform drive growth down the road.

Management hammered home the significance of Workers in Q4’s earnings call, emphasizing that the “killer application for Cloudflare Workers is turning out to be AI. The model of programming is uniquely suited for building tools like AI agents, and our serverless architecture, which allows you to pay only for what you use based on CPU or GPU type, positions Workers to become the go-to platform for developers who want the best price performance for AI inference and agentic workflows.”

Cloudflare is now capitalizing on the developer moat that it has built with Workers over the past few years, as developers continue to choose the platform due to the unparalleled efficiencies and cost advantages it can offer when it comes to AI inference. Customers executing inference tasks could pay up to 250% more with hyperscalers than with Cloudflare’s pay-per-use model, per management.

Workers also saw significant deal momentum in the fourth quarter. Cloudflare reported its largest customer win in Q4, a $20 million contract with a Fortune 1000 tech firm, that includes Workers and application security, while a leading AI firm expanded with a $13.5 million deal for services including Workers, R2, and more.

What could easily be overlooked (and what arguably is very important) was management’s discussion on GPU utilization rates. Management explained that while a typical customer at a hyperscaler “is seeing sub-10% utilization across their GPUs, our peak utilization of GPUs is now around 70%,” though troughs are much lower with room to improve in 2025. What this means is that Cloudflare “can get effectively 7 times today the amount of work out of $1 of CapEx spent,” allowing them to capture the excess either in margins or pass it on to customers via lower costs. Improving troughs in utilization should theoretically lead to faster processing times and an ability to handle more requests for customers, all while doing so for cheaper and at a higher margin.

Multiple Key Metrics Support Confidence in Cloudflare’s Revenue Reacceleration

Though Workers growth and commentary on improving GPU utilization rates were quiet drivers of the report, multiple key metrics showed growth in Q4, supporting management’s confidence that the first half of 2025 would mark a turning point with the strength of its business accelerating in the second half.

Cloudflare guided for 23.7% growth in Q1 to $468-469 million in revenue, and that is currently forecast to be the bottom for the year, with revenue expected to reaccelerate to the 27% level exiting the year. All it would take is a few beat-and-raise quarters to put Cloudflare on track to surpass the 30% growth level by the end of 2025.

Revenue growth is forecast to decelerate to 23.7% in Q1 before accelerating to 27% by year-end.

Multiple key metrics showed strong growth in Q4, with a handful of analysts praising the productivity strides and strong execution on these key metrics in the quarter:

• Acceleration in growth in >$1M customers
• High concentration of net new adds for >$1M customers in Q4
• Acceleration in paying customers
• Acceleration in billings and strong Pool of Funds activity
• DBNRR expanding

The I/O Fund first covered Cloudflare’s AI inference story for premium members in October 2023, recently closing the position for a gain of 97% and making multiple purchases in small and mid-cap AI beneficiaries. Learn more here.

Cloudflare’s Paying Customer Growth Accelerates

Cloudflare reported 173 customers in the >$1M cohort at the end of 2024, for 47% YoY growth, up from 37% growth last year. Management noted that of the 55 of the net new adds in 2024, more than half came in Q4, implying at least 28 in the quarter, and 27 combined for the other three quarters; a significant uptick.

Paying customers increased 25% YoY to 237,714 at the end of Q4, an 8-point acceleration from the start of the year. From late 2022 through 2023, growth had remained in the mid-teens, with the recent uptick in paying customers coming alongside growth in AI applications and more mainstream AI usage with numerous consumer-facing and enterprise-focused models being released. What’s impressive is that Cloudflare is matching 2022 growth rates at a nearly 100,000 larger paying customer scale. Additionally, 2 of the past 3 quarters have seen paying customers grow at 7% QoQ, suggesting that a further acceleration could be still in store.

Paying customers growth accelerated to 25% in Q4 to 237,714 forecasting strong fundamentals for Cloudflare’s stock

Cloudflare’s Billings Growth Tops 30% Again

Billings meaningfully inflected in Q4, rising nearly 32% YoY and 22% QoQ to $548 million. Growth had previously been in the low-20% range for the first three quarters of 2024. Billings likely benefited from a “notable uptick in close rates” and “an improvement in sales cycles,” with management mentioning that the majority of large customers “whose deals had slipped from Q3, reengaged and signed significant contracts in Q4.”

Cloudflare’s billings growth accelerated nearly 8 points to 32% YoY in Q4.

Pool of Funds activity was quite strong as well, with activity comparable to Q3 at around 9 percentage points; management noted that a $20 million Pool of Funds contract with a Fortune 100 tech company was the largest new customer win in company history, along with a $13.5 million deal with a leading AI firm. Pool of Funds is expected to pick up strength in the second half of the year after leading to some near-term headwinds as customers transition to these contracts.

There were other encouraging signs within ramped account executives, with management saying that they “delivered a 10 percentage point increase in ramped AEs achieving over 80% of quota compared with 2023, with most gains coming in the 125% or higher attainment cohorts.” For 2025, management is expecting YoY growth in ramped account executives to “accelerate each quarter throughout 2025, further laying the foundation for Cloudflare's next phase of growth at scale.”

DBNRR Ticks Higher to 111%

Cloudflare reported that its dollar-based net retention rate (DBNRR) ticked 1 point higher to 111%, marking the first time the metric has grown since Q3 2023. Management commented that “there can be some variability in this metric quarter-to-quarter, but we believe the recent decelerating trend in DNR is stabilizing despite continued near-term headwinds from increased traction with pool of fund contracts.”

Cloudflare’s DBNRR grew for the first time since Q3 2023 to 111%.

Cloudflare’s GPU Investments Rising

With the accelerations in billings, paying customers and strong net adds in its largest customer cohort, Cloudflare laid the foundation for increased investments to support growth through 2025. While this is likely to be slightly detrimental to margins, with management guided for an adjusted operating margin of 11.6% in Q1 versus 14.6% in Q2, it paves the way for Cloudflare to meet higher demand and reinvigorate revenue growth.

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Management said that the “accelerating shift from AI training to AI inference has given us confidence to continue to increase our investment in our GPU rollout as we provision greater capacity to support demand in 2025.” As a result, network capex is expected to be 12-13% of revenue in 2025, up from 10% in 2024.

As has been the case with hyperscalers, who had been quite vocal over the past few quarters that demand regularly outpaced GPU supply, Cloudflare signaled that its investments in GPU capacity would go towards supporting higher demand as workloads shift towards AI inference.

Cloudflare is Inching Closer to GAAP Profitability

Breaking into GAAP profitability on the bottom line is a ‘holy grail’ for cloud stocks, in part due to high SBC levels that push operating expenses above 100% of revenue. Cloudflare is inching closer to reaching GAAP profitability on the bottom, though GAAP operating income is a bit further away.

Cloudflare reported a GAAP operating loss of ($34.7 million), or a GAAP operating margin of -7.5% in Q4. Though this declined slightly from -7.2% in Q3 due to some headwinds to gross margin, it marked a 7 point improvement from the -14.4% operating margin in Q1.

Cloudflare is showing prudent cost management, bringing expenses down from 92% of revenue in Q1 to below 84% of revenue in Q4. R&D expenses ticked slightly higher sequentially in Q4, understandable given the investments Cloudflare is making in its network, while marketing expenses declined 1.4 points to 41.7% of revenue.

GAAP net margin is making strides towards positive territory, with Cloudflare benefitting from net interest income and improvements to operating margin. GAAP net margin improved from -9.4% in Q1 to -2.8% in Q4, or a loss of just ($12.8 million). This improvement comes despite SBC remaining elevated at just above 20% of revenue.

Cloudflare is currently not expected to break into GAAP profitability this year, with analysts expecting a loss each quarter of 2025. However, the improvements in operating margin from cost management efforts and a potential revenue reacceleration could shift that story. Other best of breed cloud names such as CrowdStrike and DataDog have seen strong returns after breaking into GAAP profitability on the bottom line.

Cloudflare’s Valuation Looks Elevated

Even though management is quite confident in the AI inference growth opportunities in 2025, there’s not yet tangible evidence of a reacceleration on the top-line, and Cloudflare is trading at its highest valuation in more than two years. Key metrics are showing underlying signs that support revenue reaccelerating, but the valuation amplifies risks to the downside until the acceleration story materializes.

On the top-line, Cloudflare is trading at its highest valuations since May 2022, at 28x forward revenue, above where it had previously found resistance at 22x to 23x forward revenue. This makes it one of the most expensive cloud stocks aside from Palantir, trading at a near 100% premium to DataDog and Snowflake despite all three reporting revenue growth in the high 26% to 28% range for the most recent quarter.

Source: YCharts

On a free cash flow basis, Cloudflare is the most expensive of the four here, trading at 350x free cash flow versus 250x for Palantir and 75x to 77x for Snowflake and DataDog. Free cash flow has hovered at ~10% of revenue for 2024, below Snowflake at 20% through fiscal Q3 and DataDog at 29% for 2024 due to Cloudflare’s much higher investments in its infrastructure – Cloudflare spent $185 million in 2024, versus $35 million for DataDog in 2024 and $34 million for Snowflake (through Q3).

Source: YCharts

For adjusted EPS, Cloudflare is valued at 217x forward earnings of $0.80, versus 210x for Palantir and 186x for Snowflake. This is a significant re-rating in a short period of time, with Cloudflare being valued at half of this multiple in October, at 105x forward earnings. Adjusted earnings growth is also expected to be minimal in 2025, with management guiding for barely 6% growth to $0.79 to $0.80 this year.

Source: YCharts

Conclusion

The Workers platform exhibited strong momentum through 2024 with active developers rising 50% to surpass 3 million, widening Cloudflare’s developer moat as it aims to harness growth in AI via its positioning at the edge and ability to offer high-performance, low-cost inference. A handful of key metrics inflected and accelerated in unison in Q4, a positive sign for growth heading into 2025.

Cloudflare’s management expressed confidence for 2025 on AI inference driven opportunities, with multiple key metrics suggesting that a revenue reacceleration could be in store. Given the soft Q1 and fiscal 2025 guide and elevated valuation, Cloudflare is in a spot where it has to prove that it can meaningfully inflect revenue growth based on the underlying strength in large customer deals, billings, and customer growth. We think the stock will prove this; yet we also book gains at specific price levels to reduce risk.

The I/O Fund recently entered five new small and mid-cap positions that we believe will be beneficiaries of increased AI spending after Big Tech projected capex of $320B+ for 2025. Advanced members received real-time trade alerts for each trade with entries and exits discussed Thursdays at 4:30 p.m. EST in our weekly webinars. Take advantage of our limited-time promotion for $50 off monthly Advanced plans – learn more here.

Damien Robbins, Equity Analyst for the I/O Fund, contributed to this analysis.

Disclaimer: This is not financial advice. Please consult with your financial advisor in regards to any stocks you buy.

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