According to a research note released Monday by Wall Street research firm Bernstein, the large-scale selloff in cloud infrastructure software stocks last Friday may have been an overreaction.
Although recent results from Amazon Web Services (AWS) and Twilio (ASX: TWLO) sparked market concerns about slowing cloud computing demand, Bernstein believes that Datadog (ASX: DDOG) and Cloudflare (ASX: NET) could deliver better-than-industry performance in their upcoming third-quarter earnings reports, driven by rapid growth in artificial intelligence (AI)-related businesses.
On Friday, U.S. software stocks broadly declined, with usage-based cloud infrastructure software companies experiencing particularly sharp drops, most falling 5% to 10% or more. Cloudflare shares fell 9.5%, while Datadog dropped 11.5%.
Bernstein analyst Peter Weed believes this selloff was largely influenced by the performance of AWS and Twilio. Twilio's organic revenue growth rate decelerated year-over-year, while AWS's revenue growth, although accelerating, fell short of Wall Street expectations in terms of the pace of acceleration. Additionally, both companies' outlooks for fourth-quarter business prospects also disappointed the market, further intensifying investor concerns.
Bernstein noted that the cloud computing industry is indeed facing some demand pressure in the near term. Previously, the surge in usage of AI programming tools briefly drove rapid growth in cloud service demand, but as that demand has retreated from its peak, some companies may experience a temporary slowdown in fourth-quarter revenue growth.
However, the firm believes that the situation for Datadog and Cloudflare could be different. Although both companies' traditional customer businesses also face pressure from slowing growth, strong growth in AI-related businesses is expected to offset this impact, allowing them to outperform other cloud infrastructure software companies.
For Datadog, Bernstein is particularly bullish on growth opportunities from its AI-native customers. The firm estimates that Datadog's AI-native customer base may add approximately $200 million in annualized recurring revenue (ARR) in the third quarter compared to prior expectations.
This implies the related business could generate approximately $50 million in additional revenue, though because Datadog uses a usage-based billing model with post-hoc charges, there remains uncertainty about whether this revenue will be recognized in the third quarter or the fourth quarter.
Bernstein's current forecast model primarily counts this growth in the third quarter, implying Datadog's quarterly revenue could exceed the company's previous guidance by approximately $90 million—roughly twice the magnitude of its historical best beat. However, the analyst also acknowledged that this forecast may be overly optimistic. Even if some revenue is deferred to the fourth quarter, it could still drive the company to provide strong guidance for the next quarter.
Bernstein expects that, driven by AI demand, Datadog's fourth-quarter revenue growth rate could reach approximately 40% year-over-year, although its traditional customer business growth rate may slow from approximately 28% in the third quarter to around 25%.
Cloudflare is similarly positioned to benefit from rapid growth in AI application development demand. Bernstein estimates that annualized recurring revenue for Cloudflare's developer platform Workers may have reached approximately $500 million in the third quarter, representing roughly three times its scale in the fourth quarter of 2025.
The firm believes that AI coding agents are driving enterprises and developers to adopt new application development models, rapidly increasing demand for cloud services that do not require self-managed servers. Currently, Cloudflare and Vercel are viewed by Bernstein as the two main competitors in this market.
Relevant data shows that applications deployed through such technologies have grown approximately threefold since the beginning of the year, and growth trends in early fourth quarter suggest related demand could further increase by approximately 25% sequentially.
Bernstein expects this growth could accelerate Cloudflare's third-quarter revenue growth rate by nearly 2 percentage points compared to the previous quarter, and enable it to achieve its largest beat this year. Although slowing traditional cloud service demand could cause Cloudflare's fourth-quarter revenue growth rate to decline year-over-year, continued expansion of the Workers business is expected to support 2027 growth.
Bernstein believes the company's 2027 revenue growth rate could reach over 40% year-over-year. Additionally, the firm's preliminary network traffic data shows that cloud service demand has already rebounded in October, with growth trends similar to the strong performance in the fourth quarter of 2025.
This suggests that recent industry demand pressures may be only temporary, and both companies could provide more optimistic 2027 business outlooks in the future. Despite being bullish on both companies' growth prospects, Bernstein maintains different investment ratings for them.
The firm maintains a "outperform" rating on Datadog with a target price of $350, and a "market perform" rating on Cloudflare with a target price of $245, both unchanged. Based on the closing price on October 30, Datadog traded at $235.27, implying approximately 48.8% upside to Bernstein's target price; Cloudflare traded at $280.70, with its target price approximately 12.7% below the current stock price.
Bernstein noted that although the combined growth and profitability performance of the two companies may be relatively similar, Cloudflare's valuation is significantly higher than Datadog's, making the latter more attractive at current price levels. However, the firm also believes that Cloudflare lacks obvious valuation downgrade catalysts in the near term. If the Workers business continues to grow rapidly and drives the company's 2027 revenue growth rate to over 40%, its stock price could still receive support.
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