Confluent: I Stay On The Sidelines For Now (NASDAQ:CFLT)

Thesis

Confluent (NASDAQ:CFLT) has launched a brand new method to information infrastructure referred to as Information-in-Movement. This method includes capturing and processing information in real-time throughout a number of techniques, groups, and functions in a corporation. Primarily, Confluent gives instruments that allow completely different techniques and functions to share information immediately and independently, resulting in improved operational effectivity, buyer expertise, and the creation of recent use instances. Confluent’s expertise is aligned with trade tendencies like digital transformation, machine studying, and cloud adoption, positioning it effectively for the long run. Nevertheless, the corporate remains to be buying and selling at a premium a number of, and with the deteriorating macro-outlook, I see restricted probabilities of a a number of re-rating within the near-term regardless of the corporate’s development outlook, which is why I at present hold a Maintain score on the inventory.

Publish This fall Earnings Outlook

Confluent had a good This fall by way of income and profitability, with a 3.5% beat on income and a document quarter-over-quarter Cloud income enhance of $11.5 million. Nevertheless, the expansion in bookings slowed down in comparison with the earlier quarter, with a 4% year-over-year enhance in complete bookings development and an 18% year-over-year enhance in cRPO-based bookings development. The corporate continued to draw new prospects, with a 35% year-over-year enhance in prospects producing greater than $100,000 in annual recurring income. Nevertheless, the corporate confronted challenges within the present macroeconomic setting, which resulted in elevated scrutiny of offers and longer gross sales cycles. Moreover, current buyer enlargement slowed down barely, with dollar-based internet retention coming in just below 130% for the fiscal 12 months 2023, in response to administration.

Throughout earnings name, discussions primarily targeted on Confluent’s This fall efficiency, together with elements that contributed to its outcomes and elements underlying its steerage. The corporate skilled some softness in bookings as a result of deal elongation, significantly in December, and didn’t see the everyday end-of-year price range flush that it often sees in This fall. The gross sales cycle elongation affected complete bookings greater than cRPO-based bookings. Nevertheless, the industrial section confirmed robust development and resilience within the quarter, and there have been no vital tendencies throughout geographies or verticals. Confluent stays assured in its steerage as a result of wholesome retention charges, the closure of some offers that slipped out of This fall, and consumption patterns inside its present buyer base.

There’s vital curiosity in Confluent’s stock-based compensation (SBC) and anticipated dilution trajectory. Plainly the administration goals to deliver dilution ranges according to software program friends, focusing on the 50% to 75% percentile vary for complete compensation relative to the market over time. For FY23, the corporate is focusing on 3-4% dilution and hopes to cut back this in subsequent years. As dilution decreases, SBC expense can also be anticipated to lower, though the expense is affected by inventory worth actions and has a lag because of the timing of grants. Over time, administration is focusing on SBC to be within the high-teens as a proportion of complete compensation.

Monetary Outlook

The consumption tendencies for Confluent Cloud are prone to stay steady even throughout a slower macroeconomic setting. Some use instances, corresponding to e-commerce or inventory buying and selling, could expertise a slowdown throughout an financial downturn, however there are different use instances, like regulatory reporting, which can be anticipated to be extra resilient whatever the macroeconomic circumstances.

Confluent has decreased its hiring and brought different cost-cutting measures after making vital investments in 2021 and 2022. Consequently, the corporate’s OpEx development is predicted to be slower in 2023. The corporate can also be specializing in enhancing gross sales and advertising and marketing effectivity by ramping up gross sales reps and strengthening partnerships with GSIs and CSPs. Even with out vital effectivity positive aspects, Confluent is predicted to attain its 2023 working margin goal as income continues to develop and higher-margin renewals change into a bigger portion of the combination.

Robust Market Place with Lengthy Development Runway

Apache Kafka is the core of Confluent’s data-in-motion paradigm and was created by the corporate’s founders as a free, open-source venture in 2011. It has change into the usual for real-time occasion streaming with broad-based adoption, utilized by over 300,000 organizations globally, together with 80% of F500 corporations, and has over 5 million lifetime downloads. Confluent is the one industrial firm constructed round Kafka and the one one providing Kafka as a fully-managed cloud-native SaaS providing. The corporate’s place is solidified by its experience as the unique founders of Kafka. The market alternative for Confluent is estimated to be round $60 billion, and the corporate has solely penetrated lower than 1% of this market, indicating vital development potential.

Valuation

CFLT at present trades at 7.2 EV/CY23E income, at a slight low cost to MDB and premium to ESTC. Though the sector median is sort of decrease than CFLT’s a number of, it has to do with different corporations’ slower development charges in comparison with Confluent, and I believe that Confluent has a greater probability of sustaining its development than most different software program corporations. Nevertheless, elements corresponding to increased rates of interest, recession, or modifications in investor preferences may prohibit the potential for development in software program inventory valuations. I imagine that whereas there could also be alternatives for Confluent to carry out effectively, the expansion potential of its inventory valuation could also be restricted within the near-term, which is why I at present hold a Maintain score on the inventory with no worth goal.

Remaining Ideas

Confluent’s This fall efficiency was impacted by softness in bookings as a result of deal elongation and the absence of the everyday end-of-year price range flush. Nevertheless, the industrial section confirmed robust development and resilience, and the corporate stays assured in its steerage as a result of wholesome retention charges and deal closures. The corporate’s stable market place with Apache Kafka and its potential for development make it a pretty funding; nonetheless, the inventory trades at a premium in comparison with different trade gamers and its personal historic a number of, and I see restricted alternative for a number of enlargement within the near-term which is why I stay on the sidelines for now.