CFLT - Confluent's Revenue Growth Moderates As Ecosystem Expands

2023-08-10 13:24:40 ET

Summary

• Confluent recently reported Q2 2023 financial results, beating revenue and EPS estimates.
• The company offers a platform for data infrastructure that speeds up streaming data communications across the enterprise.
• The company's stock price has increased, but I remain Neutral [Hold] due to high stock-based compensation and slowing revenue growth.

A Quick Take On Confluent

Confluent ( CFLT ) reported its Q2 2023 financial results on August 2, 2023, beating revenue and EPS consensus estimates.

The firm has created a platform providing data infrastructure that speeds data communications across the enterprise.

I previously wrote about Confluent with a Hold outlook.

I remain cautious about the prospect for further stock price appreciation, especially with high and increasing stock-based compensation of $323 million in the past twelve months.

My near-term outlook on CFLT remains Neutral [Hold].

Confluent Overview

Mountain View, California-based Confluent was founded in 2014 to create a platform enabling companies to easily build and deploy data-driven applications for real-time use.

Management is headed by co-founder and CEO Jay Kreps, who was previously a software architect at LinkedIn and was one of the creators of Apache Kafka, which Confluent uses as the basis for its system.

The company’s primary offerings include:

• Confluent Cloud - SaaS platform

• Confluent Platform - Self-managed system

• Kafka Connect - data hub

The firm pursues relationships primarily with large and medium-sized companies through a direct sales and marketing approach.

Confluent has customers across numerous industries, including financial services, retail and ecommerce, manufacturing, government, gaming, insurance, communications and media & entertainment.

According to a 2022 market research report by Market Research Future, the global market for event stream processing (as a proxy for the larger data streaming market) was an estimated $790 million in 2022 and is forecast to exceed $2.4 billion by 2030.

This represents a forecast CAGR of 12.86% from 2023 to 2030.

The main drivers for this expected growth are a growing demand for real-time analytics, increasing desire by businesses to analyze their data stores, the continued transition of enterprises to cloud applications and the need to drive efficiencies across all aspects of the enterprise.

Also, as companies transition to cloud infrastructures, their systems are becoming more complex and there is a substantial need for vendor reduction to improve integration and lower complexity.

Major competitive or other industry participants include:

• IBM

• Aiven

• Oracle

• SAP

• StreamSets

• Striim

• Imply

• Coralogix

• Ververica

• StarTree

• Materialize

• Crosser

• Quix

• Lenses

• BangDB

Confluent’s Recent Financial Trends

• Total revenue by quarter has risen markedly; Operating income by quarter has remained heavily negative, as the chart shows below:

• Gross profit margin by quarter has trended higher in recent quarters; Selling, G&A expenses as a percentage of total revenue by quarter have dropped materially more recently:

• Earnings per share (Diluted) have remained substantially negative, as the chart shows here:

(All data in the above charts is GAAP)

In the past 12 months, CFLT’s stock price has risen 9.54% vs. that of the iShares Expanded Technology-Software ETF’s ( IGV ) rise of 12.53%, as the chart indicates below:

For the balance sheet , the firm ended the quarter with $1.8 billion in cash, equivalents and short-term investments and $1.1 billion in total debt, none of which was categorized as the current portion due within 12 months.

Over the trailing twelve months, free cash used was $179.1 million, during which capital expenditures were only $3.4 million. The company paid a whopping $322.9 million in stock-based compensation in the last four quarters, the highest trailing twelve-month figure in the past eleven quarters.

Valuation And Other Metrics For Confluent

Below is a table of relevant capitalization and valuation figures for the company:

(Source - Seeking Alpha)

The Rule of 40 is a software industry rule of thumb that says that as long as the combined revenue growth rate and EBITDA percentage rate equal or exceed 40%, the firm is on an acceptable growth/EBITDA trajectory.

CFLT’s most recent unadjusted Rule of 40 calculation worsened to negative (29.0%) as of Q2 2023’s results, so the firm has performed poorly in this regard, per the table below:

(Source - Seeking Alpha)

Commentary On Confluent

In its last earnings call ( Source - Seeking Alpha ), covering Q2 2023’s results, management highlighted the continued development of its ecosystem for data streaming, which includes five areas of functionality:

• Stream

• Connect

• Govern

• Process

• Share

The company’s total net revenue retention rate was 130%, indicating very strong product/market fit and good sales & marketing efficiency.

Total revenue for Q2 2023 rose 35.8% YoY and gross profit margin increased 5.1%.

Selling, G&A expenses as a percentage of revenue dropped an impressive 15.9% year-over-year, while operating losses grew by 0.9%.

The company's financial position is moderate, with plenty of liquidity but material long-term debt and substantial free cash used in the past twelve months.

CFLT’s Rule of 40 performance has been highly negative and worsening over time due to operating losses and moderating revenue growth.

Looking ahead, consensus revenues are expected to grow by 31.6% year-over-year.

If achieved, this would represent a sharp drop in revenue growth versus 2022’s growth rate of 88.5% over 2021, indicating a declining revenue growth rate.

From management’s most recent earnings call, I prepared a chart showing the frequency of key terms mentioned (or not) in the call, as shown below:

I’m most interested in the frequency of potentially negative terms, so management or analyst questions cited ‘Recession’ once, ‘Challeng[es][ing]’ two times, and ‘Macro’ eight times.

Analysts questioned company leadership about customer consumption trends. Management responded that they saw strong overconsumption by larger customers.

Also, separately, the firm produced strong growth in new large customers, despite a ‘choppy environment’ that management sees continuing throughout the remainder of 2023.

Regarding valuation, in the past twelve months, the firm's EV/Sales valuation multiple has fallen about 18.4%, as the chart from Seeking Alpha shows below:

A potential upside catalyst to the stock could include continued strong growth in larger deals, defined as greater than $100K in annual recurring revenue, as well as overconsumption trends continuing.

The company is also pursuing further build-out of its partner channel, which is now ‘performing above plan’ and could be a tailwind over time.

The question for investors interested in Confluent is whether its current valuation multiple is a bargain, considering a slowing topline revenue growth rate but continued high operating losses.

I remain cautious about the prospect for further stock price appreciation, especially with high and increasing stock-based compensation of $323 million in the past twelve months.

My near-term outlook on CFLT remains Neutral [Hold].

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