Two years ago in the analysis Cloudflare: Bringing AI Inference to the Edge, we discussed in a deep dive on the stock why “Act 3 and the Workers platform is where the most explosive moment could occur” for Cloudflare while stating:
“[…] what’s crazy is that Cloudflare rolls out features that exceed hyperscaler performance at minimal cost. It is this combination of competing with the hyperscalers, delivering app performance at faster speeds — while keeping prices low — that is unique to Cloudflare.”
Act 3 refers to the Workers platform, which is the company’s attempt to compete with hyperscalers – but most importantly, it sets up the company well for AI inference at the edge.
Cloudflare executes runtime for an application close to the user combined with removing cold starts by running isolates that create an advantage at the edge. This is distinct from pushing compute from a centralized data center to the edge. It’s also distinct from containerized processes that require cold starts. Cloudflare also offers R2 object storage, which helps developers eliminate unnecessary fees on cloud storage. This is used by AI startups to help arbitrage the lowest GPU cost to train their models.
When it comes to AI inference-driven revenue, it’s still relatively early in the growth curve. Hyperscalers and model providers only recently began to disclose rapid AI token growth over the last three to four months. However, Q1’s earnings report shows signs of surging AI inference demand filtering into Cloudflare’s platform. For example, Q1 witnessed nearly 4,000% YoY growth in Workers AI inference requests, and more than 1,200% YoY growth in AI Gateway requests.
These growth numbers are off a small base (which is true for all inference statistics for now), yet when you take a company with product-market like Cloudflare and combine it with a massive trend on the verge of taking off – what you get is an irresistible stock that the I/O Fund has a high probability of entering and holding for an extended period of time.
Connecting the Dots:
As discussed in the product deep dive two years ago, Cloudflare’s core products as a CDN and best-of-breed leader in cloud-based security and application security including Zero Trust may not seem connected its future as an AI inference leader, but they are intricately connected. You can read more on the background of the points below and Cloudflare’s core products here.
Cloudflare references its business units as “Acts” – Act 1, Act 2 and Act 3. The company defines Act 1 as application security, Act 2 as Zero Trust and Act 3 as the Workers Platform. For our purposes as stock investors, it’s Act 3 we are most interested in. The analysis below makes it abundantly clear as to why Act 3 and the Workers platform is where the most explosive moment could occur.
Cloudflare has a few distinct advantages as the platform of choice for AI developers. Here’s a summary:
- Does not rely on Big 3 infrastructure and can drive down costs
- Is faster on performance because of its position at the edge; this lowers costs and latency for AI inference and keeps data as close to the user as possible
- Geographically equipped to handle compliance issues that will inevitably result from using training data for inference.
- The company has moved diligently into compute, storage and application services. Combined with its global network, this positions the company for AI inference as-a-service. There is no other company doing both edge network plus compute and storage except the hyperscalers. However, in some cases such as serverless, Cloudflare exceeds the performance of the hyperscalers.
- CDN as a core product and security as a seamless upgrade shows the importance of being a middleman, helping to position Cloudflare to innovate around Serverless in ways that outperform even AWS.
- Training models is prohibitively expensive by requiring upfront costs, Nvidia GPUs are hard to obtain, and AI development is not democratized for developers with proprietary, blackbox APIs that run counter to an open-source movement (GPT-4 versus Llama). Cloudflare aims to solve these problems by allowing popular models to run closer to the user, which is the next logical step for AI.
Ultimately, the bigger and the faster a network is, the more it’s capable of providing “as a service.” AI can create a fortuitous moment for Cloudflare because the company is both positioned to offer AI inference-as-a-service yet also solves important pain points for developers.
Workers AI Built for High-Speed AI Inference at the Edge
Cloudflare’s Anycast network routes traffic to the most available data centers, and can spread traffic across the entire network, improving resiliency during surges and minimizing latency. Cloudflare said in Q1 that the network now spans over 13,000 major service providers in 500 locations across 400 cities in more than 100 countries. By routing requests to the edge, Cloudflare is less than 50 milliseconds away from 99.9% of Internet traffic and 95% of the Internet-connected population.
Cloudflare recently revealed at Morgan Stanley’s Tech, Media and Technology (TMT) Conference in March 2025 that when it first developed its Workers platform nearly eight years ago, it had no idea it would foresee what AI agents would become. The platform was originally born with the idea of creating a new way to deploy code at the edge, or as Cloudflare puts it, the “Goldilocks zone of high compute performance with low latency” as close to devices as possible.
Workers has a unique platform architecture: it eliminates cold starts by running close to GPUs instead of in a container or virtual machine, executing code the second it is received. It also uses isolates, which run 100x faster than node processes and consume significantly less memory without requiring separate resource allocation. Essentially, developers pay for Javascript runtime once and can then run “limitless” scripts across hundreds or thousands of isolates, all without additional overhead costs.
It is this unique isolate-based architecture, with ultra-low latency and an ability to execute thousands of requests concurrently at minimal cost, that provides Cloudflare an advantage for AI inference. What Cloudflare offers is exactly what AI inference needs – exceptionally fast performance with no lag at the edge, as that is where the data is located.
Cloudflare is working to significantly expand GPU accessibility across its global network to serve growing inference demand, having GPUs across 190 cities worldwide as of March 2025. Cloudflare had doubled its GPU capacity in one year with more powerful GPUs as of September 2024, and is aiming to double its capacity again in 2025.
Source: Cloudflare
Cloudflare is also expanding support for increasingly large models, such as Meta’s Llama 3.1 family, and a broader range of models with its ‘Run Any’ support feature (this is limited however to models compatible with its GPU fleet and inference stack).
Cloudflare’s vector database Vectorize aids in the full-stack AI app development process by storing and remembering previous inputs. Vectorize can now support indexes with up to 5 million vectors, up 25x from 200,000 previously. Median query latency has been reduced nearly 18x from 549 milliseconds to 31 milliseconds. This allows AI apps to search and recall relevant data quickly while keeping costs lower.
By expanding access to larger models and larger context windows at faster speeds, AI apps built on Workers AI now can handle increasingly complex tasks with greater efficiency at similar or lower costs. Put together, Cloudflare says that Workers platform can end up ~3x cheaper per CPU-cycle versus competing platforms like AWS’ Lambda, at $0.50 per million requests versus $1.84 on Lambda. As developers now begin to increasingly use Cloudflare and Workers for AI API requests, they benefit directly from these lower overhead costs in addition to higher performance and lower latency offered by the global network.
These key advantages are helping Cloudflare land and expand enterprise customers with AI in mind. CFO Thomas Seifert explained that customers migrating to Workers can see cost or performance improvements of ~300% in the migration. It was this exact reason that drove its largest deal on record in Q1, a $130 million five-year deal with an existing customer, primarily for Workers. Cloudflare said this customer was deeply engaged with a hyperscaler who was confident in winning the deal, but the customer “made the decision to switch to Cloudflare when they saw our better performance, lower development costs and more modern platforms.”
AI Gateway: Additional Benefit for Enterprise AI
It is also no surprise that Cloudflare is becoming a platform of-choice for AI providers, with 80% of the leading AI companies as customers of Cloudflare. Yet it has one new, underdiscussed product that could help pave the way for broader enterprise AI adoption: AI Gateway.
Although AI Gateway was launched more than a year ago, Cloudflare has been especially quiet about the new offering. Q1 saw the first mention of growth for the product, while management said at Morgan Stanley’s TMT that it was its largest new feature that “might not have gotten enough attention yet from a Wall Street perspective.” As of October 2024, Gateway had proxied over 2 billion requests in just one year.
Gateway is a centralized AI ops platform for Workers AI. It acts as a control center for AI applications running on Cloudflare with multi-vendor observability and analytics, sitting between customer applications and AI APIs they make requests to.
Source: Cloudflare
With Gateway, customers have detailed insights into traffic patterns, such as the amount of requests, token usage, and costs over time. Customers can limit requests to help control costs, while custom response caching allows Cloudflare to make repeat requests, saving costs and lowering latency by serving from the cache and bypassing the original API. Gateway pairs natively with Workers AI and Vectorize to help developers build full-stack AI products within the platform.
Cloudflare noted that it has plans to expand features to include dynamic model routing with A/B testing, usage alerts, advanced caching and more. However, its future vision for Gateway embeds more data security tools to ease enterprise adoption and smooth other privacy concerns, a major hurdle to adoption at the moment.
Cloudflare says that in the future, its goal for AI Gateway is to transform it into a product that helps enterprises monitor how employees utilize AI. With Gateway, enterprises could route all API requests to AI providers through Cloudflare’s platform first, letting organizations log user requests, set access policies and rate limiting, and implement data loss prevention strategies. Cloudflare says that if an employee accidentally pastes sensitive data into ChatGPT, enterprises could redact that or block the request entirely, preventing it from reaching AI providers and thus into the public domain.
The end goal with Gateway is to create a platform that lets enterprises tap into efficiencies that AI unlocks while providing a high level of data security and privacy. This is a key concern – a Deloitte survey from late 2024 found that nearly 75% of tech professionals listed data privacy as a top three concern from genAI use in the enterprise. Around 40% had listed data privacy as the number one concern, up from 25% in 2023. A survey from Reveal in June 2025 also found that while 73% of tech leaders prioritize expanding AI use this year, 78% listed data privacy as their top concern.
For enterprises utilizing AI, costs trump all, as even small changes in token/API costs at high usage, such as hundreds of thousands of API calls daily, could quickly drive usage costs higher and adversely impact margins. Cloudflare’s focus on providing high visibility into AI usage, while simultaneously boosting data privacy and minimizing costs and latency provides an additional benefit when it comes to inference and AI application deployment.
Workers Shows Hints of Rapid AI Momentum
Cloudflare’s Workers platform is seeing considerable AI-driven momentum, both in active developers growth and now AI inference requests. Active developers first reached 1 million in November 2022, nearly tripling YoY. By April 2024, or approximately two quarters after the launch of Workers AI, active developers had doubled to more than 2 million.
Though Cloudflare did not provide an update in Q1 or at TMT, active Workers developers crossed 3 million at the end of 2024, marking a 50% YoY increase. Overall, this represents nearly 9x growth in just over three years.
Source: Cloudflare
Additionally, Cloudflare noted that Act 2 and Act 3 products – Zero Trust and Workers – contributed significantly to its strong ACV growth in Q1. Net-new ACV recorded its highest YoY growth in three years last quarter, with products from the two acts driving two-thirds of that.
We recently covered Workers developer growth and other strong key metrics in our free newsletter from February, Encouraging Growth in Key Metrics Drives 60% Gain YTD for Cloudflare Stock.
When it comes to AI inference-driven revenue, Cloudflare has not offered any insights, as it’s still relatively early in the growth curve. Hyperscalers and model providers only recently began to disclose rapid AI token growth over the last three to four months. However, Q1’s earnings report did show some hints of surging AI inference demand filtering over to Cloudflare’s platform.
Q1 witnessed nearly 4,000% YoY growth in Workers AI inference requests, and more than 1,200% YoY growth in AI Gateway requests. This builds upon Q4’s first large inference customer win of approx. $7 million. While growth is likely off a rather small base considering the relative newness of both platforms, it is a solid indicator of accelerating inference demand.
Capex is a bit more unusual metric to point to in support of strong inference-driven growth, but Big Tech has been straightforward in saying that AI capex is correlated with demand, and higher demand necessitates higher capex. Cloudflare’s network capex has accelerated sharply, up from 6% of revenue in Q2 to 15% of revenue by Q4 and now 17% of revenue in Q1. This quick increase in capex suggests that Cloudflare is rapidly ramping up GPU and hardware purchases to meet heightened AI demand signals.
Quarterly Growth Projected to be Flat Through 2025
Cloudflare reported a 2% beat in Q1 with revenue increasing 26.5% YoY to $479.1 million. This growth was attributed to the strength of Cloudflare’s largest >$1M and >$5M ARR customer cohorts, which saw record customer additions in the quarter.
By geography:
- US revenue rose 20% YoY to $234.9 million, or 49% of revenue. Any deceleration here as a core revenue generator could present a headwind to growth reaccelerating.
- EMEA revenue rose 27% YoY to $133.9 million, or 28% of revenue.
- APAC revenue rose 54% YoY to $73.4 million, or 15% of revenue. Cloudflare says key go-to-market strategies are producing robust growth in the region.
Looking ahead to Q2, Cloudflare guided for 24.8% YoY growth to $500 million to $501 million in revenue, representing a 1.7 point sequential deceleration. Analysts are much more optimistic on the quarter, projecting growth above the top end of the range at $501.8 million, or up 25.1% YoY.
Through the rest of fiscal 2025, growth is expected to be essentially flat around 25% YoY. However, management expressed confidence in driving a reacceleration through 2025, opening the door for potential upward surprises driven by AI inference. While flat growth does not usually stand out, each of the prior two fiscal years saw a notable deceleration in growth from Q1 to Q4 at ~4 points, with FY25 possibly set to break this trend.
It's also important to note that estimates for both Q3 and Q4 been revised slightly lower over the past three months, with Q3’s estimate down (0.6%) and Q4’s down (1.0%). This represents a decline of around $3.5 to $6 million for each quarter, or 0.5 to 1.3 percentage points shaved off of growth.
FY25 Guide Maintained at 25.3% YoY
For FY25, Cloudflare opted to maintain its initial revenue guidance of $2.09 to $2.094 billion, corresponding to 25.3% YoY growth at midpoint. Analyst estimates call for flat growth over the next few quarters but a slightly stronger second half of the year, with QoQ growth of 8% for Q3 and 7.5% for Q4 even after some negative revisions.
However, by maintaining guidance despite the $10M beat in Q1, Cloudflare is essentially saying Q2 could be softer than expected. With that said, Cloudflare tends to be conservative during macro events such as what we saw in April, and thus it could also be a non-issue.
Although we are seeing a 1 to 2 point acceleration in the fiscal year consensus estimates, the hint that there could be an acceleration is what helps Cloudflare stand apart from peers since more cloud companies are decelerating sharply below 20% growth.
For example, Snowflake’s revenue growth is forecast to decelerate from 29.2% last year to 24.7% in 2025 and below 23% next year. Datadog's revenue is forecast to decelerate from 26.1% last year to sub-19% by 2026, while MongoDB’s revenue decelerated from 31% in 2023 to a projected 13.9% this year.
Key Metrics Support Growth Acceleration
Cloudflare’s underlying key metrics are supportive of revenue growth accelerating. In the most recent quarter, the company reported accelerating paid customer growth and billings, stabilizing DBNRR, and record large customer additions.
In Q1, paid customer growth accelerated 2 points sequentially to over 27% YoY, with Cloudflare reporting 250,819 paid customers. Growth has doubled from 13% two years ago, an impressive acceleration given the scale is now reaching a quarter-million paid customers.
Cloudflare also noted it had driven record customer additions in its >$1M and >$5M ARR cohorts in Q1, with growth in both metrics up 48% and 54% YoY, respectively.
Billings growth also accelerated 1 point to 32.8% YoY in Q1, recovering from the 20% range in 2024. Billings activity likely benefitted from QoQ improvements in sales cycles as noted in Q1, as well as stronger deal activity and larger contracts.
Cloudflare’s DBNRR stabilized at 111%, though it has yet to see a strong acceleration like Palantir. Compared to last year, DBNRR is 4 points lower. Management did note that “churn rates improved in the quarter,” while they saw stabilization in customer businesses after April’s bout of volatility alongside reduced pricing pressures from competitors. These factors should provide more headroom for DBNRR to expand again as AI consumption increases.
RPO also reaccelerated in Q1 to nearly 39% YoY to $1.86 billion, though there has been consistent quarterly variability in growth over the last two years. Current RPO accounted for 66% of total RPO, down from 70% in Q4.
Margins Show NET Regressing from Path to GAAP Profitability
Margins are the one real blemish for Cloudflare, as the company has regressed on its path to reach GAAP profitability in Q1. Gross margins have been compressing slightly, due to an increase in paid versus free traffic, while operating margins slipped sequentially in Q1.
GAAP gross margin was 75.9% in Q1, down 0.5 points sequentially and 1.6 points YoY. Adjusted gross margin was 77.1%, down 0.5 points sequentially and 2.4 points YoY. Cloudflare said the softness was due to a significant increase in paid vs. free traffic which led to a “higher allocation of expenses to cost-of-goods-sold from sales and marketing,” similar to Q4.
GAAP operating margin was (11.1%) in Q1, down 3.6 points sequentially and a setback from three consecutive quarters of progress towards profitability in the (7%) to (8%) range. Adjusted operating margin was 11.7%, marginally above guidance for 11.6% and down 2.9 points sequentially. For Q2, Cloudflare guided for adjusted operating margin to improve one point to 12.6%.
As seen below, there exists a wide, nearly 23 point gap between GAAP and operating margins. This is driven primarily by high SBC at ~20% of revenue, and it highlights that either SBC would need to move much lower, or costs much lower, in order to drive Cloudflare to a sustainable path to GAAP profitability. For example, Q1’s sales & marketing expense was 38% of revenue, 10 points above Cloudflare’s long-term model of 27% to 29% of revenue.
GAAP net margin was (8.0%) in Q1, a rather substantial decline from (2.8%) last quarter, driven by the QoQ decline in operating margin. Adjusted net margin was 12.2%, the lowest reported level since Q2 2023.
EPS Growth Minimal in FY25
Cloudflare reported adjusted EPS in line with estimates at $0.16 in Q1, for flat YoY growth. Q2 is expected to see adjusted EPS decline mid-single digits YoY, with the full-year on track for just mid-single digit growth with an acceleration expected in Q4.
For Q2, Cloudflare guided for adjusted EPS of $0.18, down from $0.20 in the year ago quarter. Adjusted EPS growth is expected to resume in 2H, with EPS seen exiting the year at $0.23, up 22.6% YoY.
For FY25, Cloudflare maintained its guidance for $0.79 to $0.80, corresponding to growth of approximately 6% YoY. For FY26, analysts are projecting EPS growth to accelerate sharply to 30.3% YoY to $1.04, which likely would require solid improvement in adjusted margins given the topline acceleration is minimal.
Cash Flows & New Debt Raise
Operating cash flow continues to improve, touching a 30% margin in Q1, though free cash flows remain pressured by heightened network capex at 17% of revenue. Cloudflare also raised a substantial amount of capital on June 13, an interesting move given the company still has nearly $2 billion in cash on hand.
- Operating cash flow rose more than 98% YoY to $145.8 million, for a 30% margin. This marked a substantial 11 point improvement from a 19% margin a year ago and a 2 point sequential improvement.
- However, free cash flow rose 48.6% YoY to $52.6 million, for an 11% margin, up only 2 points YoY. This was driven by heightened network capex in the quarter at 17% of revenue, increasing from 15% of revenue in Q4 and more than double last year’s 8% of revenue.
- For FY25, Cloudflare maintained guidance for network capex to be 12-13% of revenue with some quarterly variability, which may allow FCF margin to expand throughout the year as it suggests capex spend will normalize at a lower level.
- Cash and investments totaled $1.92 billion, while Cloudflare reported $1.29 billion in convertible debt still outstanding, due in 2026.
- On June 13, Cloudflare announced it priced $1.75 billion in 0% convertible notes due 2030. Cloudflare said the conversion price is ~$247.67, and the capital will go towards general corporate purposes, including working capital, network capex, M&A or paying outstanding debt.
Valuation is the Primary Drawback
The primary drawback to Cloudflare’s AI inference opportunity at the moment is its valuation. Key metrics and comments of 12x to 40x growth in AI inference requests support revenue reaccelerating, but it is hard to justify a rapid repricing from a 16x forward revenue multiple in April until there is tangible evidence of the topline accelerating.
Cloudflare is trading at a hefty 30x forward revenue multiple, second only to Palantir’s 85x multiple. This represents Cloudflare’s most expensive valuation on a forward revenue basis since 2022, and far above historical resistance at around 22x.
Source: YCharts
While Cloudflare may have a clearer AI inference opportunity than other best-of-breed cloud stocks such as Snowflake and DataDog, it is trading at a significant premium to both. At 30x, Cloudflare is near a 100% premium to SNOW and a 115% premium to DDOG, despite all three are reporting revenue growth in the 25% to 27% range for the most recent quarter.
Source: YCharts
On a forward PE basis, Cloudflare is valued just 5% shy of Palantir, at nearly 228x forward EPS. Cloudflare is nearly 20% more expensive than SNOW at 192x forward PE, and far above DataDog’s 76x multiple. Cloudflare also has the second lowest adjusted EPS growth this year, at 6% versus 42% for Palantir, 33% for Snowflake, and (7%) for DataDog.
Conclusion
Cloudflare is uniquely positioned to capture AI inference at the edge, and we are seeing more signs of surging AI inference demand from hyperscalers. Cloudflare has been relatively quiet about AI inference-driven growth until Q1 when it dropped 12x growth in AI Gateway requests and 40x growth Workers AI inference requests.
The takeoff in AI inference is expected to drive an inflection in Cloudflare’s growth, with revenue expected to begin a prolonged acceleration through FY27, starting in the back half of 2025. However, Cloudflare’s valuation presents a real drawback after a rapid rerating higher, considering the acceleration has not yet tangibly materialized and margins regressed from a path to profitability.
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Damien Robbins, Equity Analyst at I/O Fund, contributed to this analysis
Please note: The I/O Fund conducts research and draws conclusions for the Fund’s positions. We then share that information with our readers. This is not a guarantee of a stock’s performance. Please consult your personal financial advisor before buying any stock in the companies mentioned in this analysis.
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