September Rally Eases AI Fears, But Execution Risks Remain

What happened

Cloudflare's stock rallied nearly 14% in September as the company announced several key business developments that tempered investor fears about AI-related disruption. This recovery comes after a challenging first half of 2026, marked by a 20% workforce reduction, a five-percentage-point drop in gross margin to 71%, and deceleration in remaining performance obligations growth from 48% to 36% year over year. The specific September announcements are not detailed in the article, but they likely signal progress in monetizing AI traffic or expanding enterprise contracts, which had been a key concern. However, the underlying fundamentals have not yet shown clear improvement: Q2 results are still pending, gross margin stabilization is unproven, and the restructuring's impact on sales productivity remains uncertain. As a result, the rally appears driven more by sentiment and narrative shift than by hard evidence of operational turnaround.

Implication

Investors should not chase the rally without confirmation that revenue growth remains above 30% and current RPO growth holds at or above 34% in upcoming quarters. The stock's valuation at over $270 already prices in a successful AI transition, leaving little margin of safety if gross margin fails to stabilize above 71% or large-customer growth slows. A more attractive entry point would be near $230, closer to the DeepValue report's base case, where downside risk is better compensated. Conversely, if Q2 and Q3 filings show accelerating backlog and margin improvement, the stock could re-rate toward $335, but that requires evidence, not just announcements. We maintain our WAIT rating with conviction 4.0 and will update our view after the next earnings release and restructuring completion.

Thesis delta

The September rally does not materially change our investment thesis; we remain cautious because the fundamental risks we identified—margin pressure, slowing RPO growth, and restructuring execution—are unresolved. While the positive sentiment reduces tail risk of a sharp de-rating, it does not provide new evidence that the AI-first model will yield improved profitability. We will look for confirmation in Q3 results and subsequent filings before altering our stance.