Talend - Small Company, Big Space, Big Opportunity?
Talend (NASDAQ:TLND) is yet another company that went public about 3 months ago to take advantage of what some consider a tech bubble. It is a relatively small company at this point, but unlike some of its brethren, it has not seemingly had the extreme valuation excesses that have marked many recent offerings. Talend was recently upgraded by a GS analyst.
Perhaps more importantly, the company's shares have been substantially oversold, according to those who look at things like relative strength indexes. Talend is covered by 6 analysts at the moment, and all of those except one were in the underwriting group. So, I thought the SA community might be interested in a less biased look at the outlook for the company and whether or not the shares are worth getting to know.
Talend will be releasing its earnings for the second time as a public company on 11/10. Expectations are for a loss, for this quarter, this year and next year as well. The covering analysts mostly rate it as a hold, other than GS and one other boutique brokerage. The company is seeing sequential growth that is accelerating, with its year-over-year growth reaching 38% last quarter compared to 34% in the prior quarter. Talend looks at a metric that is key to a company like this which it calls "dollar-based expansion," and which was 124% on the high side of its experience over the past 9 quarters. The growth in sequential operating expense diminished substantially, perhaps leading to some optimism regarding a path to profitability in the foreseeable future. The company is generating massive levels of deferred revenue relative to its size, and because of that, it has already become breakeven in terms of cash flow from operations (CFFO). Management has forecast that the free cash flow generation will positive for all of 2016 and beyond.
Talend was founded in France, but it is headquartered in Redwood City, CA. It reports using IFRS standards that are equivalent to US GAAP. Currently, more than 50% of the company's revenues are coming from outside of the US, which suggests it has a pretty substantial geographic runway to accelerate sales growth in this country. On the other hand, currency fluctuations will be more noticeable for this company than is the case for some of the other names in the software space.
Talend raised about $91 million in its IOP, and shares are trading about 1/3rd above the offering priced. The company's first quarterly report covered the period through June 30th before it raised capital and shows a small cash balance offset by some slightly larger level of borrowings. Presumably, the borrowings have been retired and the company has a significant balance of cash and equivalents. There would appear to be no operating reason that it has to raise more capital in the foreseeable future.
The company is using a fully diluted share count of 27.5 million shares, which yields a current market capitalization of $687 million, and its current likely enterprise value is probably around $600 million. Talend's valuation is far lower than that of many other IPOs at less than 6X sales based on the current year forecast and 4.4X EV/S based on consensus forecast of $135 million in revenue for 2017.
The title for this article comes from the show "The King and I." Late last week, King Bhumibol of Thailand passed away. I confess that I really don't have a great fund of knowledge about the king of a country I only have visited once. What little I did know about the man was that he was a friend to this country during the war in Vietnam, and his country was very hospitable to our servicemen in that period.
In any event, one of the well-known songs from the show is called "Getting to Know You." And hence the title of the article, which is about getting to know Talend and seeing if the exercise is worthwhile. I think it is!
What is Talend and why is it relevant?
Basically, the company offers a series of data integration tools that are part of a unified data integration fabric and allow users to create analytic applications, including those based on cloud data sources and Big Data volumes. There have been relatively few investments that are focused directly on the emerging trend of Big Data and analytic applications which have been enabled by that technology. It is the contention of this article that Talend is likely to be one of those companies. It competes against Informatica, owned by private equity and Ascential Software, which was in turn owned by IBM Corp. (NYSE:IBM) for many years.
I wrote an article about Hortonworks (NASDAQ:HDP), which is a company that is trying to commercialize Hadoop adhering to open system standards. So far the old saying "long and wrong" characterizes the recommendation. But the point is that this company has some of the same demand drivers that have animated the revenue growth of HDP, and that portion of the company's business has seen triple-digit growth. The jury remains out regarding HDP, and investors will see if there has been any progress when the company reports its results early next month. But the space has some of the best prospects in the Enterprise IT universe. Talend is another company whose future is tied to that of Big Data and the cloud and to the increasing torrent of data that users want to analyze as part of their decision-making process. Part of the company's product offering is the ability to be used with Hadoop and, most particularly, Apache Spark as a vehicle to integrate data from that source as well as others. Talend is part of the Apache Spark eco-system and is used in many Apache Spark solutions.
Talend has a far more flexible business model when compared to its better-known competitors that allow users to buy a low-cost platform license and then expand the range of functionality they can get from the platform. The leaders in the space - Informatica, Oracle and IBM - have long been criticized by users for inflexibility in pricing along with high TCO for anything beyond very simple applications.
Talend is, as will be discussed below, a small company with lots of products in a very large market whose leaders have been somewhat resistant to some of the innovations that users are looking to have in order to implement Big Data applications that can provide the latest analytic technology to torrents of data. The company has developed an integrated data fabric that allows users to integrate data from many sources and to use it all kinds of applications, whether on-prem, in the cloud or in Big Data use cases. Surprisingly, its largest competitors cannot precisely do that.
Unlike some of the claims that are made for Big Data technology, reducing infrastructure costs and improving performance for Big Data applications is measurable and something that is inevitably going to attract the attention of users - in this case, the users are CIOs. Infrastructure is not something that end users really see - all that concerns them is whether the tool works or it doesn't, how much it costs and how the tool plays into the performance of the application. If a tool is cheaper, if it is reliable in complex environments with many data sources and if it reduces the time necessary to cleanse and prepare data, it is something that can be readily sold to users. It appears that Talend's solutions ticks all of the boxes in terms of cost, functionality and ease of use.
Do Talend's products really have a special sauce?
In a single phrase, Talend does have some different ways to solve some common IT problems. The company makes some audacious claims with regard to the price/performance of its solution. The claims are a bit over-hyped, and while the company has TCO advantages compared to competitive offerings, its extreme claims are restricted to a few specific use cases. Talend does, however, have some compelling solutions that would appear to allow it to maintain high growth for some years to come and to successfully compete in a crowded market space.
Much of the advantage the company enjoys in terms of TCO relates to the way it prices its product, which is not based on the amount of data being processed. The company sells its solutions total based on a subscription model, although not all of its solutions run exclusively in the cloud. That is a bit different than the other licensing models in use by its competitors. For many years, the data integration space has been very stable, with the same competitors and little market share movement. Talend is the first disruptor in this space in many years, and it thus has a significantly greater competitive runway than might otherwise be the case.
It would appear from the analysis of Gartner and others that users are looking for something that is a bit more straightforward than the overly complex pricing models offered by legacy competitors. Because of the way the market space has evolved, the major competitors have wound up with siloed products that are not themselves well-integrated and lack some of the more modern features that users seem to crave. CEO Mike Tuchen, during the course of the earnings conference call, was asked about how the company has been and expects to be able to gain market share.
I will synthesize and expand on his answer, which I do believe is what is happening in the space and which, in many ways, represents the argument for owning these shares. Data integration has been one of the better spaces in the enterprise software world for many years now. The concept of the data-driven enterprise is not new, and it requires that users integrate data from numerous sources in order for it to be processed by analytic applications. Because there has been a need, there have been data integration solutions for a very long time at this point. The market, as defined by Gartner, is not immense. Most of the players in the market - and that includes Talend as well - offer products that are outside the relatively cramped boundaries defined by Gartner.
The latest report on the subject is one from Gartner dated 9/28/2016. The market, according to it, had a run rate of $2.8 billion at the end of last year and is growing at 10.5%. That may not sound terribly exciting, although the growth rate is obviously several times that of IT spending as a whole. But within that 10.5%, traditional ETL (Extract, Transform and Load) tools are showing very little growth, while tools relating to cloud apps and big data are seeing a CAGR of 40%+. Talend enjoys a growth rate of 100%+ in cloud/Big Data and a 40% growth rate overall. The company doesn't break out its revenues by segment, and the way it prices the product that wouldn't be practical, as Big Data/Cloud are features on the total Data Fabric platform. But I think Big Data/Cloud is about 25% of this company's revenue, growing at 100%, which suggests that part of the company's secret sauce as an investment is that it has a disproportionate amount of its business coming from the high-growth segment of its market.
Informatica has been the leading company in the data integration space for many years now - at least as long as I can remember. That company has 3 platforms that it offers users, 2 of which have been acquired over the years and are not basically integrated with the core offering called PowerCenter. PowerCenter has been around for a long time by now, and it is available in multiple flavors. But Informatica has totally different products for cloud data integration and Big Data management. That just isn't what users want to buy these days, no matter how happy they are with Informatica (the same comments would apply to IBM/Ascential, but it is a smaller fraction of the market). Gartner has mentioned that even some Informatica reference customers have had issues with both product messaging and portfolio architecture. Apparently, the company has reference customers who have confusion regarding how to add functionality and data delivery styles to their current deployments.
The Talend offering consists of a single data fabric which is the core of its solution. The so-called secret sauce is essentially an integrated platform which allows the company to offer users the potential to do more with its tools without the necessity of owning 3 sets of non-integrated data integration solutions. The company users pays a 20-30% uplift to the price of the core technology and gets the total functionality necessary to achieve data integration in the cloud and for Big Data analytics. There are observers who would rather see Talend price on the amount of data that goes through the applications that its tools are used to build. But that is where the company is able to enjoy a price/performance advantage compared to competitors.
The company has just started to sell what it describes as a data preparation component of its solution. Data preparation is a major component of the TAM this company addresses. Data preparation can be used by a whole raft of professionals in organizations, and its seat potential is said to be 30X that of professional developers. The Talend product is priced at 30% of the seat price of its traditional enterprise offering. Its competitors all sell different elements of data preparation separately, since basically they acquired those technologies through acquisition. This will be another significant differentiator for Talend, as the capability is part of its core platform. Obviously, data preparation has been part of data integration almost since the beginning, but it has always been part of a different silo. That has apparently been disagreeable for some users, at least according to Gartner.
The company offers a free version that can be trialed and a subscription version that is sold. I expect that the revenue from data preparation will be noticeable as a growth driver by the end of the year and into 2017.
The company has seen some acceleration of its growth most recently, perhaps as it has become better known with more references, and perhaps it has gotten more positive reviews from the larger analysts such as Gartner, IDC and Forrester. The availability of its data preparation solution is likely to further accelerate its growth rate. But it isn't as though there is some specific growth rate that has been either articulated or agreed upon by all observers. In looking at the financials and the valuation, I will use the consensus with the expectation that it is meant to embody conservative expectations that can be overattained.
Some thoughts on valuation and the company's path to profitability
Most tech companies that go public do so without earning or positive cash flow, making them more than a bit difficult to value. But it was ever thus, as the saying goes in the IPO market, and while this year saw a far smaller crop of new issues than usual, the crop that showed up lacked much in the way of standard financials that might be used in a valuation matrix. Talend is no real exception.
Before taking a deeper dive in the pool, it should be pointed out that the company did not miss its first quarter in terms of earnings. It had a capital structure that included a large slug of convertible preferred shares. Those were converted as part of the IPO process. So, Talend used a larger number of shares to compute its loss, which was therefore smaller than would otherwise be the case. Its results coming out of the gate were a beat, as might be expected, and actually were a larger beat than many other companies enjoy in similar situations. The other thing to note is that at least initially, it is not going to offer billings guidance. Management stated that there are some puts and takes with regard to some of the specific components that would be used to calculate billings that are not representative of the company's actual performance. Many analysts and this observer prefer to see billings, but that will not be happening in the short term for Talend.
The company computed its losses using 23.4 million shares in Q2, and will use a weighted average share count of 27.5 million shares, reflecting the IPO process going forward. In terms of valuation, I have used that number of shares and have estimated that most of the IPO balance is retained as cash on the balance sheet.
Talend's specific commentary on expenses was rather sparse, particularly as it related to a path to profitability. But from my own perspective, there are certainly some green shoots visible. Company CFO Tom Tuscherer mainly looked at expenses year on year in his prepared remarks. And indeed, sales and marketing expenses increased by 57%, research and development expense increased by 28% and general and administrative expense increased by 51%, reflecting the costs of the IPO. Gross margins remained flat at 75%, and that seems a number that is consistent with gross margin levels of much larger SaaS companies.
But for a high-growth company I think looking at sequential changes in spend and revenue make more sense. Just to reprise revenue growth on a sequential basis, it reached 12% last quarter, and in the prior year it was 8%. Talend has forecast that sequential growth was 4% in the summer quarter, and that it will be 11% in Q4. So, the company appears to be achieving growth rates that trend to more than 40% this year and suggest that assumptions for 2017 which call for 30% growth are quite conservative.
Sales and marketing expense, despite the very strong growth of Q2 bookings on which commissions are paid and recognized before revenues start to flow, grew by 8.6%. Research and development spending actually dropped by 7.5% sequentially. General and administrative costs were very elevated because this is a small company and the cost of an IPO is large. Nonetheless, general and administrative expense grew by just 10% in the quarter, still below the growth in sequential revenues. It should be noted that general and administrative costs included a charge paid to Square One - not Square (NYSE:SQ) - as a success fee because of the successful IPO. The success fee was about 7% of reported general and administrative costs in Q2 and was a one-time event.
Given the company's size and the fact that it is continuing geographic expansion into Australia, Singapore, Spain, Italy and the Netherlands, I think the expense ratios demonstrate a strong level of cost discipline that augurs well for future profitability. Overall, Talend is forecasting an IFRS loss of about $29 million for the full year. On that basis, it lost $13.3 million in the first half, and it is forecasting to lose $7.5 million in the quarter it is soon to report. Given the Q3 revenue seasonality, I expect the potential upside from that forecast to be small. On the other hand, I think the Q4 loss forecast is probably a bit more conservative than is warranted, given the strong sequential revenue growth anticipated. I think the set-up is good in terms of expecting significant earnings upside prints in terms of earnings, and I believe the overall momentum and the impact of the new product introduction can well produce some revenue upside as well.
As mentioned earlier, the company is forecasting positive free cash flow for this year, which suggests that the derived bookings metric is going to be strong, driven by further outsize growth in the deferred revenue balance. The CFO has suggested that such a level of growth in deferred revenues is most likely not sustainable, because this year is seeing a level of renewals that relates to contract signings three years ago. Talend is trying to reduce the length of its subscription contracts and to avoid the level of advance billings that had been on its balance sheet.
Overall, I can readily see how the current analyst consensus, which is based on 30% growth next year and a loss that is cut in half has room, is likely to see substantial upside revision as next year wears on. Talend should be able to sustain growth of well above 30% and to achieve profitably within the next 6-8 quarters on the track it is going, and that is probably worth a share value quite a bit more than 4X revenues. I think the company has every likelihood of producing significant positive alpha both in the short and the long term, and it is not inconceivable that it will be acquired.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.