INFA - Informatica: Cloud Growth Is Strong But Wait To Size Up

2023-05-31 21:30:41 ET

Summary

• I continue to recommend holding a small stake in INFA and waiting for further positive traction before increasing investment size.
• Cloud ARR growth is a positive sign, but subscription revenue growth has lagged behind, which is the key catalyst for positive share price action.
• Over time, I expect cloud adoption to gain momentum as customers realize the value proposition and the underlying demand for data transformation remains strong.

Investment thesis

It seems like the strategy to sizing the investment position small for Informatica ( INFA ) has been a wise one. Share price dipped to a low of $13.29 before rebounding to November 2022 levels. Given that 1Q23 has not shown any signs of strong positive inflection, I continue to reiterate my recommendation to hold a small stake and only size up when we see further positive traction (continuous success of migration and recovery in the macro environment). Even though FY23 guidance was reiterated, which implies a strong 2H23, I don’t see it as a strong enough catalyst to support further positive share price action (price already re-rate up from the low of $13.29 to $17 today). As I mentioned before, moving to the cloud is crucial, but it doesn't appear that the increase in cloud ARR seen in 1Q23 has accelerated growth in Subscription Revenue. Despite a year-over-year increase in Cloud ARR of around 40% since 1Q22, subscription revenue growth has lagged behind. Meanwhile, migration signs remain weak, despite the fact that maintenance keeps getting smaller (I would have expected more and more migration, not at a steady pace). This can be interpreted in two ways: either customers are not seeing the benefits of migrating, or they are simply putting off the change. I believe it is the latter, but either way, it is not positive in the short-term from a headline perspective. That said, I am still long-term positive on the business and stock, the only issue is when to size up big on the stock (not now apparently).

Cloud ARR

The good news from 1Q23 is that cloud ARR grew by 41% year over year, slowing only slightly from 42% y/y growth in the previous quarter and exceeding guidance by 600bps. In addition, cloud annual recurring revenue [ARR] increased to $32 million from $26 million a year ago, an increase of 21%. Also of note, I highlight the fact that in 1Q23, 81% of Subscription net-new ARR came from Cloud, up from 70% in 4Q22. In my opinion, all of these clearly point to uptake in cloud ARR, and it is just a matter of time when they represent a larger mix of the business, and translating to subscription revenue. When that happens, I expect growth to inflect (more so when we see an acceleration in migration). Over time, I think cloud adoption will pick up steam as customers see the value proposition (I think the current lack of migration is due to customers being wary of the future and delaying any IT implementation until later). In my opinion, pricing, and in particular the elasticity of consumption pricing based on IPU licensing, will become just as important as the functional value proposition. A customer who has purchased an IPU can track their usage and costs across the entire Informatica ecosystem with a comprehensive rate card. The most recent figures show that the IPUs are resonating with customers; they now make up 41% of total cloud ARR, up from 38% in the previous quarter, and 45% of new cloud bookings.

Looking forward, my views are in line with management, in that they have projected 2023 to be the lowest point for total ARR growth. The Cloud segment, which is experiencing the highest growth rate, will become the largest portion of the business by the end of 2023. As INFA discontinues actively selling new self-managed deals, this mix shift impact is inevitable (unless INFA stops growing which I don't see it happening). Consequently, I anticipate that in 2024, INFA will experience an upward inflection in the growth rate of total ARR.

Underlying demand

I stress once again that I believe INFA to be experiencing a robust secular tailwind. Today, many businesses struggle to keep track of their data. With INFA, customers can easily and quickly manage their data without wasting a lot of time. INFA's strategic alliances with other industry heavyweights give them a competitive edge. Not only is their platform user-friendly, but it also has the potential to boost productivity across the board for any company that implements it. So, it doesn't surprise me that management says raw demand is pretty good, despite the uncertain macro environment. As businesses pursue AI-powered digital transformation, data transformation is naturally taking center stage. I see this shift happening sooner or later, so it's just a matter of timing for the demand flow. Companies that fail to adapt during this period of change will be left in the dust when the cycle shifts again.

Conclusion

I maintain my recommendation to hold a small stake in INFA stock and wait for further positive traction before increasing investment size. The guidance for FY23, although reiterated, doesn't seem to be a significant catalyst for further share price action. The increase in cloud ARR is a positive sign, but the growth in subscription revenue has lagged behind – which is the catalyst to positive share price action in my opinion. I believe that over time, cloud adoption will gain momentum as customers realize the value proposition, and the underlying demand for data transformation remains strong.

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