CWAN - Clearwater Analytics: Reiterate Buy Rating On Good Q4 2022

Summary

• CWAN offers cloud-based IAaaS software that has displaced rivals in the market due to its flexible and scalable multi-tenant architecture.
• The 4Q22 earnings report shows progress in transitioning nearly 80% of ARR to the new pricing structure, with an encouraging increase in NRR.
• I remain optimistic on CWAN's investment case due to their successful transition to the new pricing structure, gross retention rate, and recent logo wins.

Overview

To give a quick overview of Clearwater Analytics ( CWAN ), it offers cloud-based Investment Accounting-as-a-Service (IAaaS) software to reduce manual labor, increase efficiency, and improve accuracy in reporting risks. The multi-tenant architecture utilized by CWAN ensures that all customers' data is kept in isolation while still being supported by a unified security model. I believe this strategy has helped CWAN displace rivals in the IAaaS market by making it more flexible and scalable than on-premise legacy systems or single-tenant cloud solutions.

In my opinion, the 4Q22 earnings report is consistent with the guidance given by management on the 3Q22 earnings call. The amazing thing is nearly 80% of ARR has consented to either contract modifications or price increases under existing agreements. Rapid progress in this transition has led to a strong sequential improvement in NRR of ~300 bps (3Q22: 103%; 4Q22: 106%). That said, although it may take some time for CWAN to reach its previous high-water mark of 111% in NRR, it can help close the gap by providing distinct pricing for additional modules and products. Additionally, the new base-plus model has been adopted by nearly all new customers, which can help bridge the gap in the medium term. That aside, while there is no explicit information on bookings, it's important to keep an eye on the discrepancy between the ARR growth vs midpoint of management's outlook for FY23. Moreover, the EBITDA margin expansion has been progressing at a slightly slower pace than expected, which is also worth monitoring. Overall, even with the state of the market, I still think CWAN is a good stock to have in the portfolio.

4Q22 results highlights

4Q22 revenue of $82.7 million was ahead of consensus at $80.3 million thanks to a $2.7 million contribution from JUMP, and adjusted EBITDA of $24.3 million was ahead of consensus at $22.6 million. NRR for 4Q22 was 106%, up from 103% in 3Q22, which is encouraging given that the company's ongoing pricing transition was anticipated to stabilize NRR. What is disappointing, I find, is that despite the fact that CWAN is anticipated to see a slowdown in ARR in 4Q22, the 16.4% year-over-year increase in ARR to $323.5 million is still well short of the low 20s it had aimed for. For FY23, management is projecting revenue of $361-364 million, which is above consensus, and adjusted EBITDA of $97-98 million, which is below consensus.

Another highlight is that, as far as I can tell, there was little resistance from buyers to the new pricing structure, as indicated by the fact that gross revenue retention remained at 98%. I'm also impressed and pleased to hear that CWAN was able to successfully transition 80% of their ARR from clients to the new pricing structure in under a year. Management also highlights they have won 10 new logos in 4Q22.

SS&C report

Something to note is that SS&C Technologies Holdings' ( SSNC ) Asset Management Clients segment grew 4.5% year-over-year in 4Q22, and the I&IM division, which serves Insurance clients, grew 4.9%. Based on these metrics, it appears that CWAN is continuing to gain market share.

Guidance

Profitability in 1H23 is likely to be affected by the uneven seasonality of the year brought on by the integration of JUMP and the costs associated with the newly hired sales team, according to management's guidance for 1Q23. Also, management is guiding to flat EBITDA margin despite a strong expected growth.

Conclusion

As a whole, I found 4Q22 results pretty good, and the FY23 guidance was good as well, as such I'm maintaining my optimistic stance on the CWAN investment case. Importantly, I find it remarkable that CWAN was able to convert over 80% of its ARR to the new pricing structure in less than a year, all while maintaining a gross retention rate of 98%. This just shows how much value CWAN is bringing to the table. I also think that new module pricing and recent logo wins are also positive developments that could further enhance CWAN's growth.

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