AI cloud demand drives reacceleration in Cloudflare growth, but high valuation pressures stock returns

Overview

The report argues that Cloudflare is benefiting from AI-demand-driven expansion of production workloads, infrastructure modernization, and application development growth driven by AI coding agents. Second-quarter revenue growth meaningfully exceeded expectations, while enterprise customer expansion, large deals, and partner pipelines all improved. Based on this, Bernstein restored a positive view on the company's growth outlook and raised its medium- to long-term revenue forecasts, but still maintained a Market-Perform rating given the extremely high valuation and a target price significantly below the current price.

Core views

The core views include: first, Cloudflare is expected to share in the incremental demand benefiting cloud infrastructure companies such as AWS, Datadog, and Twilio, with recent growth trends being strong; second, the enterprise sales system and flexible contracts will cause fluctuations in the timing of revenue recognition, with good third-quarter performance expected, a possible brief slowdown in the fourth quarter, and renewed strengthening in 2027; third, existing customer expansion, growth in customers above $100,000, net new ARR, and RPO improvement support continued upward movement in revenue growth; fourth, margin improvement targets strengthen the long-term profitability narrative, but pressure on gross margin from the Workers business and the current high valuation remain important constraints.

Analysis framework

The report evaluates growth momentum by combining quarterly results and guidance variance, enterprise customer expansion, net retention rate, net new ARR, RPO, number of large customers, and direct sales channel contribution, while using AWS network metrics as a near-term proxy signal for cloud demand. At the forecasting level, the report reassesses the impact of the enterprise sales model and flexible contracts on revenue timing; at the valuation level, it determines the target price using a 50/50 weighted approach between DCF and comparable price-to-sales valuation.

Methodology notes

• Absolute valuationDCF

  Discounted cash flow

  Uses a 10% weighted average cost of capital and a 3% perpetual growth rate to estimate the company's long-term cash flow value, assigning it a 50% weight in the target price calculation.

• Relative valuationForward price-to-sales ratio

  Comparable company multiple valuation

  Applies a 16x price-to-sales ratio to sales over the next 5 to 8 quarters, referencing the valuation framework for cloud SaaS companies with operating margins above 10%, and assigns it a 50% weight in the target price calculation.

• Operating metrics analysisCloud infrastructure leading indicators

  Assessing demand trends through AWS network metrics and customer expansion data

  The report treats AWS growth as a bellwether related to Cloudflare growth, while tracking net retention rate, number of large customers, ARR, RPO, and channel contribution to assess the sustainability of near-term growth.

Asset mapping & comparison

Structured mapping from thesis to named assets (strengths, weaknesses, peers, risks).

• Cloudflare Inc (NET.US)

  Core research subject and beneficiary of AI-driven cloud infrastructure

  Strengths

  Strong global edge network, developer platform, security product portfolio, enterprise customer expansion, and partner pipeline.

  Weaknesses

  Free cash flow margin remains relatively low, the Workers business may depress gross margin, and the mixed consumption and contract model reduces revenue predictability.

  Comparison

  Shares the upward trend in cloud demand with AWS, Datadog, and Twilio, but enterprise sales and flexible contracts make its revenue recognition cadence more complex.

  Risks

  Excessive valuation, cloud growth slowdown, poor execution in the sales model transition, and hyperscale cloud vendors entering the core CDN and security markets.

• DATADOG INC (DDOG.US)

  Comparable cloud infrastructure software company

  Strengths

  Benefits from expansion of production workloads and growth in cloud usage.

  Weaknesses

  Sensitive to cloud consumption trends and enterprise technology spending.

  Comparison

  The report groups it with Cloudflare as a beneficiary of incremental cloud demand, but Cloudflare is more affected by enterprise contracts and revenue timing factors.

  Risks

  Slowdown in cloud consumption growth and software valuation compression.

• TWILIO INC (TWLO.US)

  Reference company for cloud platform demand trends

  Strengths

  Can benefit from growth in AI applications and digital interactions.

  Weaknesses

  Demand is related to application activity and enterprise spending cycles.

  Comparison

  Together with Cloudflare, it reflects a recovery in cloud infrastructure and application activity, but their business product mixes differ.

  Risks

  Demand volatility, intensifying competition, and valuation changes.

• AWS

  External leading indicator for Cloudflare's recent growth

  Strengths

  Strong network metrics indicate that cloud infrastructure demand remains healthy.

  Weaknesses

  It is only a correlation proxy and cannot fully represent Cloudflare's own orders and revenue.

  Comparison

  AWS growth has historically been correlated with Cloudflare growth and can be used to help assess near-term demand.

  Risks

  Breakdown in indicator correlation, and hyperscale cloud vendors such as AWS entering Cloudflare's core markets.

Key data

• Second-quarter revenue$696.061 millionUp approximately 36% year over year, 4.7% above the midpoint of guidance, exceeding it by $31.6 million.
• Target price$164.00Raised from $136.00; implies 42% downside versus the closing price of $284.43.
• FY2026 revenue forecast$2,944 millionHigher than $2,168 million in FY2025.
• FY2027 revenue forecast$4,037 millionThe report expects the 2027 growth rate to enter the mid-to-high 30% range.
• FY2026 free cash flow forecast$393.96 millionThe forecast compound growth rate for free cash flow from FY2025 to FY2027 is 61.6%.
• FY2027 free cash flow forecast$680.03 millionCorresponds to further release of operating leverage.
• Adjusted EPS forecastFY2026 $1.32; FY2027 $1.98The FY2027 forecast is above the prior $1.73.
• Long-term profitability targetFree cash flow margin of 30% to more than 35%The company also targets GAAP profitability in FY2028.
• Sequential growth in large customer base6%Accelerated from 3% in the first quarter.
• Valuation levelFY2026 EV/Sales 34.2x; FY2027 24.9xHigh valuation is an important reason the report maintains a neutral rating.

Impact & implications

At the operating level, AI applications, infrastructure modernization, and enterprise security demand are expected to continue driving higher Cloudflare revenue growth, while the enterprise sales system and partner channels may further amplify the contribution from large deals. At the financial level, revenue growth and expense control are expected to improve the free cash flow margin and drive GAAP profitability in FY2028. However, the current share price already reflects growth expectations far above the report's target price, and even if fundamentals continue to improve, valuation compression may still dominate medium-term stock performance.

Risks

• Cloudflare's growth remains linked to overall cloud computing demand, and the macro environment or a slowdown in cloud spending could pressure revenue growth.
• There are execution risks in the transition of the enterprise sales model, and the mix of flexible contracts and consumption models reduces revenue forecast visibility.
• AI-related products need to establish credible capabilities and demonstrate real customer demand, and the pace of commercialization may fall short of expectations.
• Hyperscale cloud vendors such as AWS may further enter CDN, edge computing, and security business areas.
• Expansion of the Workers business may pressure gross margin.
• There is uncertainty around successor recruitment and team stability after the departure of key sales executive Mark Anderson.
• The current valuation is extremely high, and even with strong operating performance, valuation mean reversion may still lead to significant share price downside.

What to watch

• Whether third-quarter growth can continue, and whether the brief slowdown expected by the report appears in the fourth quarter.
• Changes in net retention rate, existing customer expansion, and the number of ARR customers above $100,000.
• Whether net new ARR and current and non-current RPO can continue to be driven by large deals.
• The contribution of enterprise direct sales and partner channels to new revenue.
• Actual usage and commercialization progress of AI coding agents, Workers, Vite, and related developer platforms.
• The pace at which SSE products replace first-generation vendors and the cross-selling performance of the broader security platform.
• The pace of progress toward the free cash flow margin target of 30% to 35% and the achievability of GAAP profitability in FY2028.
• Progress in recruiting a new sales leader and the execution stability of the enterprise sales team.