Cloudflare (NYSE:NET) stock has fallen quite considerably in the last month or so. As I suggested in two previous articles in December 2021, NET stock was way too high, and its valuation was unsustainable. But now it looks like it could be possible to invest safely in the stock.
At close on Jan. 26, NET stock was down to $80.07 per share, well below its $217.25 closing price on Nov. 18. That is a decline of $137.18 per share, or 63% off of its recent peak in the past three months.
I had previously argued that the company’s negative free cash flow and its high valuation would likely lead to a much lower price. This seems to now have played out quite dramatically and very quickly.
As a result, it might be worthwhile to take a second look at this cloud-based security technology company.
Where Things Stand at Cloudflare
In my Dec. 8 article, I argued that Cloudflare could end up treading water as its earnings and revenue catch up with the valuation. But now the opposite has happened. This price has fallen to the point where the valuation looks interesting.
Although the Dec. quarter results are not yet in, analysts have been raising their forecasts for both 2021 and 2022 revenue estimates. This allows us to take another look at the NET stock.
For example, Seeking Alpha’s survey of 21 analysts has an average of $646.9 million for 2021, and Yahoo Finance has an average of $647.6 million (using Refinitiv’s analyst survey data). These forecasts are about 50% greater than the $431 million in revenue the company made last year.
But more importantly, analysts’ forecasts for 2022 show that they expect revenue will keep rising quite well. Seeking Alpha’s analyst survey shows a forecast 37.1% rise to $887 million. Yahoo Finance shows a rise to $888.4 million, a forecast gain of 37.3%.
In other words, if these projections come to pass, it is highly likely that Cloudflare will be able to post a significant profit and/or free cash flow for the year. That will likely push NET stock significantly higher.
On top of this, Cloudflare is not going to run out of cash anytime soon, even if its cash burn takes longer than expected to turn positive. It has $618.2 million in cash on its balance sheet and $1.196 billion in additional marketable securities.
NET Stock Valuation
As of today, Cloudflare has a market valuation of approximately $3o billion. That means that its price-to-sales (P/S) ratio for 2022 using the Yahoo Finance projections is just 33.8 times revenue.
But more importantly, its future P/S ratios look very reasonable. Seeking Alpha projects that by the end of 2024, it will have produced $1.85 billion in sales. This lowers its P/S multiple to just 16.2 times. Granted, it will likely be about 25% higher on a present value basis, but it still shows that the multiple is much lower.
Moreover, let’s assume that Cloudflare can expect to become profitable this year and next year. As a result, I project that NET stock could be worth at least $40 billion or so within the next two years. That is based on a free cash flow margin of between 25% to 30% by the end of 2024. This brings its FCF to about $400 million, and at a 1% FCF yield, the value will be $40 billion.
What to Do With NET Stock
This is 33% higher than today’s price, which could take two years to achieve. That implies a compound return of about 15.5% annually for the next two years. This is a pretty good return for most investors, even though it could take two years for this to work out.
So, now that NET stock is down significantly from its peak, it might be worthwhile to begin wading into the stock.
On the date of publication, Mark R. Hake did not hold any position (either directly or indirectly) 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.