Cloudera: Buy The Crash

Summary

• Cloudera's stock tanked 27% after posting Q4 results.
• The company posted a significant beat to fourth-quarter expectations, but missed terribly on FY19 guidance.
• FY19 guidance of $435-$445 million implies just 20% y/y growth, after growing 41% this year.
• Such steep deceleration is difficult to believe, and Cloudera will likely outperform against its guidance as per usual. The selloff will be short-lived.
• Cloudera will host an investor day on April 12, where more clarity will likely be shed on the guidance issue.

Take a deep breath, Cloudera (NYSE:CLDR) investors. As a fellow longtime Cloudera long, I was stung by the news that my position crumbled 27% in after-hours trading despite a strong fourth-quarter release, virtually decimating all the gains the stock has made in recent months.

Cloudera - the open source Hadoop software company - is widely recognized as one of the most ill-performing software IPOs of 2017. Versus other high fliers that went public around the same time like Alteryx (AYX) and Appian (APPN), which have each doubled from their IPO price, Cloudera has stagnated for the past year. Things began looking up in March, when the stock broke past $20 despite a wider tech pullback - but these gains were instantly crushed right after the company's Q4 earnings and guidance release. See Cloudera's year-to-date chart below:

CLDR data by YCharts

The pain is magnified now, but it's likely to be short-lived. Cloudera has beat earnings expectations by a wide margin in every single quarter since going public - it's carved out a reputation as a serial conservative guidance-giver, a classic '"underpromise, overdeliver" schema. This quarter the company beat its guidance range and Wall Street consensus by 7%; last quarter, it beat by 5%.

If we apply this ~5% buffer on top of the 20% y/y guidance that Cloudera gave for FY19, we can bridge the gap to Wall Street's consensus expectations for FY19. There's no justifiable reason for this fantastic, fast-growing data software company with huge industry tailwinds and strong customer recognition to suddenly see its >40% growth rate get cut in half next year. Investors might get the short end of the stick now with the poor guidance range, but Cloudera will make up for it with a continued succession of "beat-and-raise" quarters in FY19 as it did this year. In fact, Cloudera management specifically pointed out that its FY19 guidance was based on extremely conservative assumptions in the company's net expansion rate among existing customers, one of the biggest drivers of revenue growth.

A quick valuation check - at $17.87, where Cloudera closed in after-hours trading, the company has a market cap of $2.52 billion. Netting off the company's $461 million in cash (it also has no debt), Cloudera carries an enterprise value of $2.06 billion.

Against the $435-$445 million guidance range Cloudera gave for the coming year, that's a measly multiple of 4.7x EV/FY19 revenues - significantly below where other high-growth software stocks are trading around 6x, 7x, or 8x. And that's if we take the company's lowball FY19 guidance at face value - in all likeliness, the company will pull ahead by $5-$10 million, perhaps more. In my view, Cloudera is a no-brainer long, and I'm going to use the pullback as an opportunity to add more shares and bring my average cost down. I'm long with a price target of $23, representing 6x EV/FY19 revenues.

A look at the good quarterly results that were largely ignored

With all the negative drama swirling around guidance, Cloudera's solid Q4 results were mostly overlooked. The strength seen in Cloudera's fourth quarter, in my opinion, is a more telling sign of its future performance in FY19 than its overly conservative guidance. Here's a look at the company's full results:

Figure 1. Cloudera Q4 results

Source: Cloudera investor relations

Cloudera reported revenues of $103.5 million in the fourth quarter, up a stunning 42% y/y (and accelerating 150 bps over Q3's growth rate, by the way; which was in a further acceleration from Q2's growth rate of 39% y/y). This was the first time Cloudera crossed the $100 million quarterly revenue milestone, putting it at a >$400 million run rate for the first time in the company's history.

Analysts, on the other hand, were only expecting $98.6 million, or 35% y/y growth. This marks a massive 7-point beat this quarter - a huge achievement for a company at Cloudera's scale. The fact that the strength of Cloudera's beat was largely ignored in the guidance miss is truly regrettable.

Subscription revenues in the fourth quarter grew a lithe 50% y/y to $84.3 million, also an acceleration over 48% y/y subscription revenue growth in Q3. Cloudera also posted a net expansion rate of 136% - meaning that on a net basis, the company managed to upsell 36% more to its installed base of customers.

Billings strength disproves weak FY19 outlook

Quarter over quarter, Cloudera also increased its deferred revenue balances by $60.0 million, indicating that its billings in the quarter (revenues plus the change in deferred revenues) were a massive $163.5 million, meaning that Cloudera added a huge amount of deals to its revenue backlog.

Note also that Cloudera's sequential billings growth of 71% (from $95.6 million last quarter to $163.5 million this quarter) was much stronger than sequential revenue growth of 9% (from $94.6 million last quarter to $103.5 million). Though sequential billings growth is often a noisy metric due to the fact that the fourth quarter tends to book a lot more deals (due to IT leaders dumping their overflow budgets for the year), the sheer billings strength in Q4 can't be ignored.

Given that billings gives investors a picture of revenue pipeline twelve months out, Cloudera's huge billings strength this quarter somewhat dispels its weak outlook. The company guided to just $435-$445 million in revenues (+20% y/y), versus analyst consensus of $460.2 million (+25% y/y). It's also calling for a sequential decline in Q1 revenues ($101-$102 million, versus $103.5 million this quarter), something that the company has never done in the past. Management did announce a re-organization in Cloudera's earnings call that included the search for a new global sales head (something that usually has a minor impact on deal activity), but it's unlikely that a sales org shuffle could cause this much disruption to revenue. Below is the commentary on the sales impact from Jim Frankola, Cloudera's CFO:

"As we offer guidance, it is important to understand that we take into account to transition the leadership and our refined go-to-market strategy to ensure focus on those customers and prospects with the highest propensity to buy and consume our software. Although potentially producing uneven results in the short run we have initiated these changes to enhance the company’s posture for sustained long-term growth."

Especially when considering the fact that Cloudera's growth has hardly ever gone significantly below 40% in any given quarter, I'm loath to believe that FY19 will bring growth of just 20%. More than likely, there is 5-10 points of conservative buffer baked into Cloudera's guidance range, one that it will extend in a series of "beat-and-raise" quarters through the next year.

One important point to note: in a Q&A response on the earnings call, Cloudera's CFO further expounded that the company based its 20% revenue guidance on the very low end of Cloudera's historical net expansion rate of 120-150% (it was 136% this quarter). Because net expansions from existing customers make up a larger portion of Cloudera's revenue growth relative to new business, this conservative assumption is extremely key to producing the lowball guidance number. If net expansion outperforms - as it did this quarter, showing no deterioration from Q3's net expansion rate of 135% - revenue growth will overachieve as well.

For that reason, Cloudera's initial 20% growth guidance should be viewed as a "low" case - not the bona fide outcome with the highest probability.

Profits leap forward

Cloudera's improvements on the bottom line also deserve an honorable mention. The company's GAAP operating losses shrunk to just -44% in the quarter, a massive 40% improvement from -84% in 4Q17. Cloudera used to be known as a huge loss generator, but these losses are slimming down extremely quickly. In particular, the company was able to shave off 16% of sales and marketing spend as a percentage of revenues and 27% off general corporate overhead, producing a huge operating margin expansion.

The company's pro forma EPS of -$0.10 also hovered extremely close to breakeven, and beat analyst consensus of -$0.23. The company also maintained its goal of hitting cash flow positive status in FY20 (one year from now). It already came close to breakeven this year, with OCF of -$42.3 million for the full year FY18, a huge improvement over -$116.6 in FY17.

Key takeaways

Cloudera's struggles are likely to be short-lived. This episode hearkens back to February 2016, when sales execution issues caused data visualization software company Tableau (DATA), then a high-flying darling of the stock market, to take down its guidance and send the cross crashing by more than 40%. The company has since recovered and showed robust 60% appreciation over the past twelve months.

Cloudera's situation is a lot more mild. It's not facing sales execution issues, just a transition in sales leadership. And the guidance bakes in the very low end of its possible range of net expansion rate outcomes, a metric in which Cloudera has materially outperformed in the past several quarters.

Stay long on this fantastic infrastructure software name. The company is trading at bargain-basement values at under 5x forward revenues, and with all signals pointing to bullish results in FY19 - huge billings, strong retention rate, and massive margin improvements - it will recover extremely quickly.

Analyst’s Disclosure: I am/we are long CLDR. 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.