Cloudera: Compelling Valuation With Multiple Ways To Win

Summary

• Dramatically undervalued – EV/FY2021 Sales ~1.9X which is a ~70% discount to highly comparable SaaS peers with similar growth and market characteristics.
• ~$100+ million in free cash flow this year. Currently ~$500 million in net cash.
• Massive total addressable market of ~$26 billion estimated to double to ~$52 billion in the next 3 years.
• Attractive acquisition target for PE and numerous strategic parties with Icahn owning 19% with 2 board seats including Chairman.
• Only true hybrid and multi-cloud company (makes sure data in private, public, hybrid and multi-clouds work together) with new transformative products that are the hidden gem of cloudification.

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Key Points

Current Value

• Current Enterprise Value (~$1.6 billion) is ~1.9x FY 2021 revenue v. ~6.2x for its SaaS peers that are highly comparable with similar growth and market characteristics. Although, ~40% of the comparable companies generate a negative cash flow and most don’t have as large a TAM or transformational new products
• $785 million - $795 million in FY 2020 expected revenue (year ending 1/31/20)
• FY 2021 guidance – We estimate the company will guide revenue growth of ~10% to $865 million to $880 million. We believe they will guide solely based upon their large, highly stable current customers making achieving that growth rate nearly 100% assured.
  • We believe the Company will internally target >15% growth to $900 million to $930 million (>50% above their anticipated ~10% guidance). The following will drive incremental revenue above the 10% guide:
    1. CDP Public Cloud, which has already been released to tremendous customer reviews
    2. CDP Private Cloud - scheduled to be launched in 2Q
    3. Cloudera’s proprietary binaries are now behind a paywall, which will drive new streams of revenue
    4. New customers
• Expect ~$100 million in Free Cash Flow in FY 2021 (internal targets are likely $115 million - $125 million). This equates to a 11.5% Free Cash Flow margin
• Stock down ~36.4% year-to-date absent any company specific news
• This business is relatively insensitive to COVID-19

Fundamentals

• Growth will accelerate with transformational new products being released
  • CDP (Cloudera Data Platform) is unlike any other enterprise data solution and solves what enterprises need for private, public, hybrid, & multi-cloud environments
  • Big data analytics is a strategically important, massive addressable market (~$26 billion)
• 977 enterprise customers spend over $100K in ARR with >150 spending over $1 million
• Carl Icahn owns 19% with two board seats including an Icahn portfolio manager as Chairman
• New CEO Rob Bearden founded Hortonworks, successfully sold 4 businesses and was the original architect of the partnership with IBM
• The original rationale behind the Cloudera and Hortonworks merger remains
  • >$125 million in cost synergies achieved with >$60 million additional cost reductions anticipated

Catalysts

• Consistent execution as revenue reaccelerates and Cloudera starts to trade in-line with its SaaS peers
• Sale to either strategic or financial buyers as the asset is truly strategic and unique (note: Morgan Stanley has been retained)
• Announce partnerships with public cloud vendors (Amazon, Google & Microsoft)
• Reversion to the mean of its software peers as investors begin to appreciate the value of Cloudera’s tech stack along with its unique value proposition
• Analysts increase their price targets once Cloudera proves that the worst is behind them and bookings reaccelerate
• Continue to release CDP on schedule with CDP Private Cloud in beta soon
• Initiate a stock buyback with >$100 million of its ~$500 million in net cash

Strategic Value

• What is a software business worth that has a sticky enterprise customer base, transformational new products, growing >10% and generating >$100M in FCF?
  • Near Term: $15 - $20+ based off historical sales multiples that financial and strategic buyers have paid for SaaS businesses
    • A near term sale reduces macro risk and avoids 2020 election risk
  • Long Term: $20 - $30+ with execution and reacceleration of revenue growth
    • We believe they will earn their way to 100%+ multiple expansion

Introduction

Founded in 2008, Cloudera helps enterprises turn data into actionable insights. Businesses and governments are creating more data than at any point in history, and everyone is currently trying to figure out how to get the most use out of their data. Cloudera helps with that by providing value throughout the data life cycle (data ingest all the way to machine learning). According to a 2018 Forbes article, over 90% of the world’s data was created in the last two years. Data is growing at an incredible pace and the need to derive insights from that data is of utmost importance to enterprises globally.

Cloudera is obviously not the only company trying to help enterprises gain insights from their data. Naturally, Cloudera needs to have a value proposition where they are differentiated from their competitors. That differentiation comes through what Cloudera likes to call the “Enterprise Data Cloud.” The enterprise data cloud aims to let enterprises run any sort of workload on any infrastructure while allowing it to be transparent, secure and economical throughout the whole process. Achieving the Enterprise Data Cloud is a lofty goal, but it’s clear to see that the payout could be enormous.

In 2019, Cloudera returned ~5% compared to the ~35% return for the NASDAQ. That only tells part of the story. Cloudera has gained ~51.3% from its 52 week low in June as the business has shown signs of life from its merger with Hortonworks after a rocky start to 2019.

We have a long history with Cloudera as we successfully invested in Hortonworks pre-merger. We believe a similar attractive opportunity exists with Cloudera now. Our objective is to give background on how Cloudera got to where it is today while also stating our case for substantial upside.

History of Merger

Cloudera and Hortonworks announced their merger on October 3^rd, 2018. The day after the merger was announced, the combined market cap of both Cloudera and Hortonworks was ~$4.9 billion. Compare that to the current market cap of ~$2.1 billion. Is the combined Cloudera and Hortonworks now worth ~57% less than when it was announced? The day after the merger announcement has so far been the high watermark for the combined EV of Cloudera and Hortonworks. So what has caused so much value destruction since October 2018?

Source: Capital IQ

The Cloudera and Hortonworks merger was initially well received. Shares of both companies were up over 10% the day after the merger was announced. It was easy to see why the investment community was so bullish on the combination of the #1 and #2 competitors in the space. The combined Cloudera would be stronger due to scale, decreased pricing pressure and becoming the industry standard. Cloudera would also be leaner with over $125 million in annualized cost synergies. Finally, Cloudera would be more innovative after putting the best engineers in the data management space under one roof. Things haven’t gone exactly as planned for Cloudera since the announcement of the merger. Here’s why:

1. Overly optimistic guidance
2. Accounting adjustments that caught the investment community by surprise
3. Culture clash
4. Market perception of Hadoop
5. Executive turnover

Overly optimistic guidance

The initial S-4 filed by Cloudera in November of 2018 painted a rosy picture for the immediate future. The S-4 forecasted ~$966 million in revenue for FY 2020 (ending 1/31/20). In the merger presentation released on October 3^rd, 2018, Cloudera also indicated that they would have 15%+ operating cash flow margins by FY 2021. On Cloudera’s Q4 earnings call on March 13^th, 2019, revenue guidance for the FY 2020 was slashed to $845 million at the midpoint while the goal of 15% operating cash flow margins would be pushed out a year. Things would get worse from there. During the Q1 call on June 5^th, 2019, FY 2020 revenue guidance was further cut to $755 million. $755 million in revenue equated to 0 – 10% annual recurring revenue growth for a business that had been growing north of 25%. Growth in Cloudera had evaporated in a matter of quarters and the stock price suffered due to it. Cloudera closed at ~$14.61 on March 13^th, 2019 before Q4 results were announced. Cloudera closed at ~$5.21 on June 6^th, 2019 which was the day after Q1 results (both the CEO and Co-Founder of Cloudera were forced out). That June earnings call was one of the worst earnings releases we have ever seen. Simply put, the call was an unmitigated disaster with elevated churn and dramatic miscommunication with the street. Due to this, over 60%+ of Cloudera’s market value had been lost in less than 3 months.

Source: Company Filings and Transcripts

Why did this guidance prove to be overly optimistic? Management totally underestimated just how difficult integrating this merger would be. Mergers aren’t easy with more mergers than not failing. In Cloudera’s case, disruption wreaked havoc as implementation wasn’t as quick or painless as management expected. Culture (more on that later) caused disruption in the sales and engineering teams. Cloudera didn’t come out with a product road map until March. Finally, the announcement of the CDP platform resulted in the Osborne Effect taking place. All of these things caused customers to either delay orders with Cloudera, move to self-support or to take their business to the public cloud providers. Competing cultures, lack of visibility into Cloudera’s future and customers waiting for CDP resulted in a massive revision of expectations following the merger.

Accounting Adjustments

Cloudera had two major accounting adjustments after the merger that seemed to catch investors by surprise. The first was a $62 million negative revenue adjustment for FY 2020 due to purchase price adjustments. The second was a $125 negative impact to billings and cash flow in FY 2020 due to adapting Hortonworks to Cloudera billing practices. Both of these types of adjustments are commonplace in a merger. However, our belief is that investors were confused as to why the adjustments weren’t contemplated in guidance given beforehand. Tom Reilly (Cloudera’s previous CEO) had this to say on the Q4 call:

So from a Cloudera perspective, when you look at the bridge from the S-4 to our guidance, there aren't any significant surprises. So merger disruption synergies, dis-synergies are a little bit more than we anticipated. The purchase price adjustment is the other big thing. Other than those 2 things, it's all noise.

The investment community was clearly unaware of the “noise” beforehand. Changing billing practices happen. Revising operating cash flow margin targets outward due to billing changes just looks like poor planning on management’s part. The same holds true for the purchase price adjustment. Again, both are reasonable adjustments to make during a merger. The investment community took offense because these adjustments weren’t properly communicated.

The sheer amount of changes caught analysts flat-footed. Price targets and models had to be adjusted. Poor communication of adjustments along with a total unpreparedness for possible disruption created an analyst community that now looks at Cloudera skeptically until proven otherwise.

Culture Clash

Combining rival cultures is not easy. In an April article by Virginia Backaitis (Technology Talent Scout and blogger at Medium), Virginia called it “insulting” that Mick Hollison, CMO of Cloudera, had mentioned that all it took was a few drinks for the Cloudera and Hortonworks sales staff to cozy up with each other. We wholeheartedly agree with Virginia. Cloudera and Hortonworks sales staff had previously been fierce rivals. Sales staff would sell the merits of Cloudera over Hortonworks and vice versa. Now the combined sales staff would be tasked with telling their customers that they’re better off together. From what we understand, the work environment of the merged company was initially toxic rather than cozy.

Asking the engineering teams at Hortonworks and Cloudera to join together was no small task. Cloudera and Hortonworks had two different views towards open-source. That sort of decision really matters to engineers. To Cloudera’s credit, it appears that the engineering team has executed well thus far given that CDP currently is on schedule. Their progress wasn’t as evident in June when Cloudera was trading at its 52-week low and CDP public cloud hadn’t been completed. Credit to Arun Murthy, CPO of Cloudera, and the engineering team for coming together and executing so far.

Culture is not something to be ignored when deliberating a merger. While it’s hard to quantify, culture is ultimately what can make or break a merger. A Forbes article speaks to how crucial culture is and why it can’t be ignored.

Market Perception of Hadoop

A google search of “Hadoop is dead” will return a litany of results. Given that he is one of the foremost experts on Hadoop, we highly recommend this article by Arun Murthy (CPO of Cloudera) aptly titled “Hadoop is Dead. Long live Hadoop.” HDFS with MapReduce is Hadoop in its traditional sense. However, that is not what Cloudera is and hasn’t been for some time. As Arun pointed out, Cloudera and “Hadoop” help enterprises store, manage, secure, govern and analyze data. Cloudera will embrace the technologies that allow businesses to do the most with their data. Increasingly, Cloudera is utilizing Spark, Kafka, Flink (just added to CDP), Kubernetes and more to improve the enterprise experience. Many of the businesses that utilize these technologies (Snowflake, Databricks, Confluent, etc.) sport valuation multiples that dwarf Cloudera’s current valuation. These businesses aren’t commonly associated with Hadoop, and they have been rewarded with higher multiples as a result (they also are growing at 100%+ for comparison). Finally, the failure of MapR in May of 2019 distorted perception. MapR was the #3 player in the space behind Cloudera and Hortonworks. Initially MapR was rumored to be liquidated under chapter 7 of the bankruptcy code, but MapR was ultimately acquired by HPE in August 2019 for what was rumored to be less than $100 million. MapR was valued at over $1 billion in 2016. Cloudera was hit with the perfect storm of disappointing results, the failure of a competitor and a growing belief that “Hadoop” was dead. All of these things heavily weighed on the stock price in 2019.

Executive Turnover

Cloudera experienced a large amount of turnover in the last year. The two screenshots below are from January of 2019 (top) and January of 2020 (bottom). From there you can see that Tom Reilly (CEO), Amr Awadallah (CTO & Co-Founder), Mike Olson (Chief Strategy Officer & Co-Founder), Britt Sellin (SVP, Human Resources), Amir Siddiqi (SVP, Professional Services) and Charles Zedlewski (GM, Product and Business Units) are no longer with Cloudera. Additionally, Hillary Mason (GM, Machine Learning) announced that she left Cloudera in September 2019 with this tweet.

Source: Cloudera

Turnover is to be expected initially with a merger. However, this was far more than usual. In the span of a year Cloudera had lost its CEO and two of its Co-founders. None of these were planned exits when the merger was announced as far as we know. This amount of change will rarely be a positive for a stock. Turnover has declined recently which should provide stability.

What’s Next?

The first half year after the Cloudera and Hortonworks merger appeared as a shining example of Murphy’s Law. The June Q1 earnings call was an absolute disaster and was easily the low point in Cloudera’s history. Management underestimated the amount of disruption they would face after completing this merger, and the stock has materially underperformed the market over the past year as a result. Still, we believe that this merger was the appropriate decision and shareholders will ultimately be rewarded.

Cloudera and Hortonworks was an all-stock merger. The split in shares was 60%/40% for Cloudera and Hortonworks respectively. This sort of transaction is much more akin to a marriage than your run of the mill acquisition where one side is gaining control. With this merger, both sides undoubtedly did extensive due diligence on the other party before agreeing to a deal. This tells us that both Cloudera and Hortonworks were convinced that they needed to merge in order to succeed in the long run. While that doesn’t guarantee success, we believe that it warrants attention.

The combined Cloudera and Hortonworks has a much better chance of competing against the public cloud providers than what either of the companies could have accomplished individually. Management has learned their lesson the hard way when it comes to setting expectations. Cultural differences should largely be a remnant of the past. Finally, there’s no longer any confusion on where Cloudera is headed. Cloudera is headed towards an open-source and hybrid-cloud future with CDP.

CDP

The strategic rationale behind the Cloudera and Hortonworks merger is CDP, and a massive investment has been made in developing it. $125 million in cost synergies along with improved pricing power are strong merger rationale. However, the main reason for the merger was what the two engineering teams at both Cloudera and Hortonworks could accomplish together. Combining the best of both the CDH and HDP platforms created a best-of-breed product on-premises, but both teams have worked together to create a product that truly meets the needs of enterprises in a hybrid-cloud world. It took longer than many anticipated, but Cloudera is a true hybrid-cloud provider.

We would like to highlight what we consider to be the main points of CDP:

• Run workloads anywhere: CDP allows enterprises to be able to run data workloads where it makes the most sense. This seems obvious, but this hasn’t been easy until now. Some workloads make sense to run in the cloud. Different clouds have different advantages. You may want to use AWS in one case and Azure in another. If the workload is privacy sensitive or long-lasting, it probably makes more sense to run that in the data center or private cloud. CDP allows you to make that choice easily as the only Enterprise Data Cloud
• Secure & Governed: Cloudera’s SDX (Shared Data Experience) has been referred to as Cloudera’s “secret sauce” in the past. SDX is huge for any enterprise that may need to move data across clouds or data centers. To keep things simple, SDX allows an enterprise to secure & govern that data easily. From there, SDX makes it easy to apply those same policies to wherever you move the data. In essence, it is critically important to be able to securely control data and SDX does this
• Full Suite of Tools: CDP provides the tools needed to analyze data throughout the data life cycle. Hortonworks historically had a stronger footprint in data streaming which comes at the beginning of data’s journey. Legacy Cloudera had a stronger footprint in machine learning. By combining the best of both, enterprises have a suite of tools to accomplish whatever they need from their data
• Alleviates previous pain points: A huge knock on Cloudera in the past was that it was hard to use. Standing up a cluster on-premises would take a large amount of training and time to be able to utilize. Firms were moving their workloads to the public clouds because they could accomplish the same result without the hassle. Cloudera had a public cloud product, but they would be the first to admit that their public cloud product wasn’t a true competitor to the products of the public cloud providers and optimized cloud solutions (Snowflake, Confluent, Databricks, etc.). CDP fixes those pain points with its new cloud-native platform that’s a true competitor in the public cloud space. In fact, CDP should turn a pain point into a strength. By being the only Enterprise Data Cloud, CDP offers functionality along with security & compliance that the cloud-native point solutions can’t offer
• Cloud-Bursting: A true differentiator, Cloudera truly doesn’t care where the workload is run (location agnostic). The public cloud providers can’t say the same. They may have hybrid-cloud capabilities, but they want data moving to the cloud at the end of the day. Cloud-Bursting with CDP allows enterprises to utilize CDP in the data center or private cloud, and it allows customers to “burst” the workload to the public cloud should the need arise. It offers the best of both worlds. It provides the security and cost savings of a private cloud, but it also offers the ease of use and consumption pricing of the public cloud
• Single Pane of Glass: This allows users of CDP to see all of their workloads in one single console. That means you can view your CDP, CDH and HDP clusters in one place. The same holds true for your on-premises and cloud deployments. The single pane of glass allows enterprises to control access as well for security purposes. The ability to see your entire Cloudera deployment in one place is a unique differentiator
• Object-Storage in Data Center: An advantage of the public clouds is object storage. Simply put, object storage allows enterprises to utilize storage at a much cheaper price than what is possible under block storage (current data center storage). Through Apache Ozone, Cloudera will be able to make it much more efficient to run workloads in the data center
• Open: CDP will be open to other ecosystems. It will work with other applications, platforms and infrastructures. What does this mean? It means that as you grow with Cloudera you don’t have to worry about being locked in. The stickiness of CDP comes from its ability to work with other platforms

The essence of CDP is creating a holistic solution to what customers need to analyze data. Enterprises need the ability to move workloads across clouds and data centers. Enterprises need a consistent security framework to allow the movement of that data. Enterprises need to know that their suite of tools they utilize will work with each other. CDP answers those needs. A Forbes article released in March 2020 by Patrick Moorhead (founder at Moor Insights) referred to CDP as the “hidden gem of cloudification.” Patrick also compared the current Cloudera to Microsoft when Satya Nadella became CEO. Why’s that significant? It’s significant because Microsoft’s stock price has returned 300%+ over that time period compared to ~100% for the NASDAQ. Patrick does a fantastic job of illuminating just how massive of an opportunity Cloudera has in front of them. If CDP makes it both easier and cheaper to analyze data, there is immense growth potential.

Open-Source

In July of 2019, after the merger with Hortonworks was completed, Cloudera announced that they would become 100% open-source. Cloudera had previously hinted at this move, but the formal announcement made waves throughout the development and investment community. Previously, Hortonworks had been 100% open-source while Cloudera utilized a hybrid open-source software model. Customers were apprehensive towards expanding their existing Cloudera or Hortonworks footprint without clarity on future licensing before the 100% open-source announcement. A huge benefit to the open-source decision is that customers no longer need to fear vendor lock-in. A blog post by Charles Zedlewski (Former SVP of Products) & Arun Murthy (Chief Product Officer) on the decision to become 100% open-source has three main pillars:

1. Freedom from vendor lock-in
2. Utilizing community standards rather than Cloudera standards
3. Open ecosystem

Customers can be confident that Cloudera will champion the best projects coming out of the open-source community and that the other applications, platforms and infrastructures a customer utilizes will work with Cloudera.

Many enterprises and investors fear the move to open-source. 100% open-source has a spotty history of success. Critics of open-source often point to Red Hat being the singular example of a software firm shunning proprietary software successfully. Luckily for Cloudera, they have a senior executive (Paul Cormier) from Red Hat serving on Cloudera’s board helping oversee the open-source transition. We also believe the notion that an open-source company can’t succeed is quickly becoming dated. We’d point to tech darlings such as Confluent, MongoDB, Databricks, GitHub, Elastic and more as prime examples that open-source can be done and done successfully. It’s increasingly being shown that 100% open-source can be best for both customers and the business. Cloudera is as well-equipped as anyone to be another success story for open-source.

100% open-source doesn’t mean that Cloudera is giving out its product for free. Cloudera also announced that binaries will be behind a paywall moving forward. This is a big development given only source code will now be given freely. Why does this matter? Essentially, binaries compile source code and allow machines to read the code. Without the binaries, the source code can’t be read by a computer. Think of binaries like a white paper from a quantitative investing firm that discusses a new factor within their model. You can see what the firm is saying and there can be discussion and improvements built around it, but the readers don’t have the actual model (applicability). In Cloudera’s case, the applicability comes from buying a subscription. There’s reason to believe that the binaries decision might bring back customers that had chosen to move to self-support. In the Q3 2020 call in December of 2019, Martin Cole (former interim CEO and chairman of the board) said:

For example, we know there were customers who had indicated their intention to self-support that elected instead to renew their subscriptions in Q3. Since our compiled software will no long be freely accessible, these customers concluded that they prefer to renew their subscription agreements.

Rob Bearden echoed these sentiments as well when he spoke at the Needham Growth Conference on January 14, 2020.

Another change for Cloudera is the adoption of the AGPL license. An AGPL license is a “Copyleft” license. Essentially, an AGPL license requires anyone who modifies the code to publish the changes made to the code. This licensing decision is intended to deter public cloud players from taking what was previously Cloudera proprietary products and using them for their own commercial purposes. It’s great for developers while bad for those that want to commercialize what Cloudera created.

Here’s the two main takeaways for the move to 100% open-source:

1. Open-Source is better for the customers
2. Open-Source could be the best financial model for Cloudera

Icahn

Icahn Capital first publicly disclosed an activist position in Cloudera on August 1^st, 2019. Less than two weeks later, Icahn Capital came to a standstill agreement with the following concessions from Cloudera:

• Icahn would limit its stake in Cloudera to no more than 20%
• Cloudera would increase the size of the board from 9 to 10 with the board moving to 11 when the CEO was hired (Only 8 were sitting on the board at the time, so Icahn filled an empty board seat)
• Icahn would receive two board seats with terms expiring at the 2021 annual meeting. The two board seats are contingent upon Icahn maintaining a 15% stake in Cloudera. The two board appointees are as follows:
  • Nicholas Graziano: Appointed to the M&A Committee. Nicholas Graziano is a portfolio manager for Icahn Capital and currently serves on the board of Xerox, Herc, Herbalife and Conduent. On 1/13/20, Graziano was named Chairman of the Board
  • Jesse Lynn joined the board and was appointed to the CEO search committee. Jesse serves as general counsel at Icahn Enterprises and currently is as a director at both Herbalife and Conduent. Jesse was named the head of the nominating committee on 1/13/20

Icahn currently owns ~19% of Cloudera with an average cost per share of ~$6.09. Icahn has made a ~21.5% return on Cloudera in a span of 7 months.

Given that Icahn Capital’s representatives are both Chairman of the Board and Chair of the Nominating Committee respectively, Icahn has an outsized influence. Cloudera was without a permanent CEO for over half a year and ultimately hired Rob Bearden in January 2020. Bearden has a deep familiarity with the business and a history of operating businesses that ultimately get acquired. This is exactly the type of CEO that you bring in if you are looking to sell the business. This doesn’t guarantee a sale is imminent. Rob Bearden has a great track record, and he could have been seen as the right person to lead Cloudera over the next few years. Still, we contend that Rob Bearden makes a lot of sense if you’re looking to sell the business given his deep familiarity with Cloudera, history of sales execution and the ability to sell businesses. With Graziano as chairman, Icahn will fight for shareholder value along with a decreasing likelihood that Icahn would look to exit Cloudera soon. Finally, Cloudera hired Morgan Stanley as a financial advisor in 2019 when Icahn first built his stake and currently could be helping Cloudera run a sales process.

Icahn has a critical choice to make moving forward. It’s clear that Icahn has an outsized influence on the company. Icahn could push for a sale now and book a modest gain in less than a year. Conversely, he could remain patient to allow for further Cloudera execution and greater share price appreciation. This scenario offers the greatest reward but also added risk with execution and macro risk such as the 2020 election, COVID-19 and monetary policy.

Rob Bearden

On January 13^th, 2020, Rob Bearden was named CEO of Cloudera. If that name sounds familiar it’s because Rob was the former CEO of Hortonworks before the merger and was/is serving as a board member post-merger. Upon announcement, shares reacted negatively initially with a ~6.0% intra-day drop before recovering to being down only ~1.4% by market close.

Without fail, Rob Bearden is the best plug & play CEO that Cloudera could find. There is nobody else that could step into the CEO role and be ready to contribute from day 1 like Rob Bearden can. He’s familiar with the product, the employees, customers, partners and has been actively dealing with the business over the past year serving as a board member. Additionally, Rob has been a fierce advocate of open-source for quite some time. Hortonworks was fully open-source under Bearden. He is a prudent choice to lead Cloudera through the launch of CDP. As evidence, the two tweets below from Suresh Srinivas (Co-Founder of Hortonworks) and Virginia Backaitis highlight their approval of the Rob Bearden CEO announcement:

Ultimately, we believe that the Bearden announcement makes a sale of Cloudera more likely. Bearden has sold 4 businesses. In his previous role at Docker, Bearden sold Docker’s enterprise division to Mirantis. He was instrumental in the Hortonworks merger with Cloudera. Additionally, Bearden served as the COO of both SpringSource and JBoss before their acquisitions by VMware and Red Hat respectively.

Rob Bearden’s compensation package heavily incentivizes a sale of Cloudera. Rob is being paid an annual salary of $600K with an annual target bonus of $500K. Where Rob Bearden is really benefiting is through RSU’s (Restricted Stock Units). He was awarded ~1.6 million RSU’s that vest in increments of 1/12^th quarterly over the next 3 years. Naturally, these RSU’s accelerate and become fully vested in the event of a sale. Assuming a sale price range of $15 - $20, Rob Bearden’s RSU’s would be worth between ~$24 - ~$32 million. That is a huge payout if Cloudera is sold.

Market Trends

Market trends are working in Cloudera’s favor. We already know that data creation is growing at a rapid pace. Businesses are requiring more and more insights from their data, and our belief is that Cloudera is attractively positioned to help businesses gain insights from their data. Cloudera is working towards a hybrid-cloud world. AWS, the world leader in public cloud computing, has validated Cloudera with AWS Outposts. AWS Outposts gives Amazon hybrid-cloud capabilities by putting AWS Outposts servers in the company’s data center. Even though the AWS validation should be more than enough, below are a few reasons why hybrid-cloud and market trends in general are working in Cloudera’s favor:

• Cloud Bill Shock: Businesses are starting to learn that running everything in the cloud is not necessarily economical. For businesses that have constantly running workloads it becomes far pricier to run in the public cloud rather than their own data center. The most efficient ways for these businesses to run workloads is a hybrid-cloud architecture
• Spark and Kafka: Cloudera users run Spark and Kafka within Cloudera’s platform on a regular basis. Cloudera management noted this when they spoke at the Wells Fargo TMT Summit in December 2019. Spark is the backbone behind Databricks while Kafka is the backbone behind Confluent. Both of those companies are highly valued tech businesses that are growing rapidly. Both Spark and Kafka are technologies that many believe is replacing what they call Hadoop (HDFS + MapReduce). We see it as a positive that businesses are choosing to utilize Spark and Kafka through Cloudera
• Fear of Vendor Lock-In: A business doesn’t want to get stuck with a single provider for any part of how the business analyzes data. The best way to avoid vendor lock-in is to utilize products that are both open-source and infrastructure agnostic. CDP is fully open-source and works on-premises and with the major public cloud providers
• Data Governance and Security: Businesses are creating more and more data and there is an increasing amount of threats of attempts to hack that data. That means that you need to know that the data you create is secured and easily transportable. Cloudera’s SDX experience makes sure that the data you create is protected but also easily transportable to different infrastructures
• Compliance: Enterprises are increasingly being held responsible for the data that they have when it concerns customer’s privacy. The easiest examples are healthcare and banks. The data that they have must be compliant with industry/government standards. We see regulation around how data is stored and used only becoming more restrictive. This is a positive for Cloudera as they can help enterprises make sure that the data they analyze and retain are in compliance with regulations
• Hadoop is Growing: Use cases of “Hadoop” are growing. Most data doesn’t come ready for an operational database which necessitates technologies like Hadoop to gain insights from the data. This Twitter thread does a great job of visualizing that Hadoop is alive and well. For those that don’t want to read the whole thread, the tweet below shows that those contributing to Hadoop is only growing

Valuation

Source: Cap IQ Estimates

Source: Cap IQ Estimates

We will value Cloudera in two separate ways:

1. Analyzing what Cloudera’s peers are currently valued at and applying an appropriate implied valuation based on a line of best fit
2. Valuing Cloudera based off historical purchase price multiples for SaaS businesses

Valuing Cloudera Based off Peers

Cloudera’s SaaS peer group (similar growth rates and size) currently trades at ~6.2x FY 2021 EV/Sales. Compare this to Cloudera’s current multiple of ~1.9x FY 2021 EV/Sales. Analysts project Cloudera is growing at 10.5% v. 15.7% for its peers (FY 2021 consensus estimates), but Cloudera still trades at a deep discount to fair value after accounting for lower revenue growth. So what do we believe to be fair value for Cloudera? In the figure below, we examine what Cloudera’s trading price would be if it traded at the multiple implied by its revenue growth rate (if Cloudera traded on the slope in the chart above). Additionally, we examine what the implied valuation would be if revenue growth accelerated to what we believe is achievable (15%).

Valuing Cloudera Based off M&A Multiples

The sale of Cloudera seems to be the most likely scenario. Because of this, it’s critical to examine what multiple has been paid for SaaS businesses. Historically financial and strategic buyers have paid ~5.2x and ~7.5x forward revenue respectively on average. Strategic buyers often pay higher multiples given strategic rationale and greater synergies from an acquisition. Also note we use a higher share count in this analysis to account for RSU’s and options that would vest in the event of a sale.

Path to Closing the Valuation Gap

To reach the ~6.2x multiple of peers mentioned above, Cloudera has work to do. It remains possible if Cloudera executes. Cloudera must do these six things to see their valuation come in-line with peers:

1. Execute on current guidance
2. Deliver FY 2021 guidance that shows revenue growth is returning (10-15%)
3. Change the narrative around the market that Cloudera serves
4. Generate substantial Free Cash Flow in FY 2021
5. Be credible
6. Release CDP Private Cloud on schedule to positive reviews

Thoughts on Valuation Discount & Cloudera’s Business Model

So why does Cloudera currently trade at such a large discount?

• Revenue growth had decelerated
• Lack of credibility following the merger
• Perceived lack of profitability
• Company is misunderstood
• Analysts have historically been wrong on the name (to the downside and upside), so they are hesitant to upgrade

Cloudera uses a land & expand business model, which leads to new clients spending more every year with Cloudera. The landing of these new clients is generally initially unprofitable, but clients have a positive ROI over time as they expand. Cloudera described its unit economics at an investor day in April 2018. New customers cost ~$250K to acquire but only generate ~$71K in recurring revenue on average. It takes between 2-5 years for a customer to become profitable as they expand. Of note, that ROI breakeven number doesn’t account for the customers that churned and left Cloudera during that time frame either. It takes a large investment and upfront losses to create a profitable client.

Fortunately, larger enterprise customers are highly profitable and have sticky relationships. Currently, 977 customers spend over $100K in ARR and more than 150 customers that spend more than $1 million. These customers require far less S&M spend as a % of revenues than smaller customers. Cloudera can achieve their growth targets just by expanding relationships with existing customers. Additionally, these customers have far lower churn rates than customers with lower annual spend (ARR).

Source: Cloudera Analyst Day Presentation

So what’s the point? The point is that a large portion of its revenue base is already profitable and will grow. Therefore, the current valuation discount is unwarranted. Cloudera becomes very profitable as a whole when the amount of $1M+ ARR customers is exceeding the new customers that are joining. Think of it being akin to a critical mass that Cloudera must achieve. Cloudera already generates free cash flow. However, the economics become extremely attractive in the long-term with a larger customer base. The long-term model aims for 30% operating margins. We’ve already indicated that slowing revenue growth will be reversed with the rollout out CDP. If you combine the high profitability margins at maturity along with accelerating growth with CDP, Cloudera should be more attractive to the investment community along with potential strategic and financial buyers.

Cloudera has a market cap of ~$2.1 billion today. To put that in perspective, Cloudera’s market cap was ~$2.9 billion as a standalone company after the Hortonworks merger was announced. Essentially, the market has erased the entire value of Hortonworks along with ~28% of standalone Cloudera over the last ~1.5 years. We’ve already highlighted that the merger vastly improves Cloudera’s tech stack along with accelerating a path to profitability, but the current stock price allows investors to buy all the benefits that the merger entails while getting the entire value of Hortonworks for free. That is as asymmetric of an opportunity that we have seen.

To summarize, we believe that Cloudera could be worth between $15 - $20+ to an acquirer in the short-term. We also believe that the current ~70% discount to peers for Cloudera is nonsensical. Longer term, Cloudera is worth $20+ provided they continue to execute, reaccelerate bookings growth and earn multiple expansion.

Catalysts

We look for investments where there’s multiple ways to win. Relying on a single catalyst is risky, so investments where one can still profit even if Plan A or Plan B doesn’t work out is imperative. Here’s what we believe to be the major catalysts for Cloudera over the next 12 months:

Execute

Cloudera trades at a deep discount to its peers for a variety of reasons. The two main reasons are poor execution post-merger and a dated perception of Cloudera’s tech. The first reason can be alleviated by Cloudera achieving their financial guidance without also giving future guidance below analyst expectations. If Cloudera can accomplish this, they should re-rate towards its peer group as the reasoning for a discount to its peers diminish. Additionally, reacceleration of revenue growth due to CDP should cause Cloudera to re-rate both due growth in-line with peers and positive expectations.

Businesses invest upfront to spark future growth. Currently, Cloudera spends the most on R&D + capital expenditures among its peer group. However, Cloudera only ranks in the 27^th percentile for Enterprise Value. That indicates that Cloudera is investing for a much larger future than its valuation would currently indicate.

Potential Sale

Cloudera is a unique asset. They are the undisputed leader in helping enterprises run analytic workloads on-premises. Cloudera additionally moved into hybrid-cloud at an early stage in development which is being validated by the public cloud players push into a hybrid-cloud environment. Additionally, a sale of Cloudera is possible if not likely given Icahn’s influence. Both strategic and financial buyers would be interested.

Strategic buyers like IBM, Oracle, Teradata and HPE would be potential acquirers. All of these businesses are looking to be a leader in the hybrid-cloud future. Public cloud providers (Amazon, Microsoft, Google) could also benefit from acquiring Cloudera. Acquiring Cloudera gives cloud providers a huge footprint in the on-premises sector.

IBM in particular has strategic rationale given their open-source leadership with their $34 billion acquisition of Red Hat along with IBM’s partnership with Cloudera (IBM and Cloudera sell products for each other). IBM further sharpened its focus on cloud computing with the appointment of Arvind Krishna as CEO and James Whitehurst as President. Arvind Krishna was the head of the cloud and cognitive-software division while James Whitehurst was formerly the CEO and President of Red Hat. IBM is making an aggressive push into being the premier hybrid-cloud vendor. Cloudera is the type of business that could help IBM differentiate themselves in the space and is a logical acquisition target. Finally, Rob Bearden originally orchestrated the IBM partnership when he was CEO of Hortonworks.

Financial buyers would also be interested in Cloudera. Large private equity firms such as Apollo, Blackstone, Hellman & Friedman, KKR, Silver Lake, Thoma Bravo, Vista Equity and Warburg Pincus could easily afford to buy the business. Private equity buyers could help reaccelerate growth while also improving margins. Of note, the merger proxy disclosed a financial buyer came forward to suggest a Cloudera/Hortonworks combination before the actual merger.

We noted previously that Morgan Stanley is working as a financial advisor to Cloudera. Additionally, the merger proxy for Cloudera/Hortonworks disclosed that both strategic and financial buyers were interested in purchasing the combined Cloudera. We believe that Cloudera would garner significant interest in a sales process.

Announce Partnerships

Craig-Hallum believes that Cloudera could soon announce partnerships with AWS and GCP to help provide a hybrid-cloud experience for customers (Cloudera already has a partnership with Azure). Announcing a partnership would bring two huge benefits:

1. Change the sentiment around Cloudera. Partnerships with AWS and GCP would represent a validation of Cloudera’s CDP platform
2. Opportunity to drive material revenues from those that are currently utilizing AWS and GCP

Conservative Analysts

Analysts have been burned by Cloudera since the Hortonworks merger. On the merger announcement, Cowen raised their price target for Hortonworks from $20 to $30 while Citi indicated the combined business could be worth between $24 - $31. Cloudera now trades at a fraction of those price targets. The flawed execution of Cloudera post-merger has created embedded pessimism/conservatism amongst the analyst community. The average rating for Cloudera is a hold with a price target of ~$12. Analysts justify Cloudera’s significant discount to peers due to lack of clarity around the end-market and the business itself. As Cloudera executes and the perception about Cloudera’s value proposition begins to change, analysts will increase their price targets and recommendations.

Reversion to Mean

Cloudera should trade upwards as investors realize the viability of the business. The reversion to the mean could happen for Cloudera as the shareholder base has seen material turnover. Additionally, a reversion to the mean could happen as Cloudera changes the narrative around their business. Rather than being the company known for Hadoop, Cloudera wants to be known as the company for the Enterprise Data Cloud. The power of re-branding may allow Cloudera to trade in-line with its peers.

Snowflake IPO

Snowflake is set to IPO in 2020. We believe this could be a positive catalyst for Cloudera. While Cloudera would say they are more than a data warehouse and Snowflake would highlight they’re a best-of-breed cloud-native / cloud-agnostic data warehouse, the two businesses are ultimately SaaS peers. We mention the Snowflake IPO due to Hortonworks price appreciation when Cloudera IPO’d in 2017. Hortonworks shares were up over 30% in the first month after Cloudera’s IPO. Hortonworks did have a positive earnings release just a few trading days after the Cloudera IPO, but much of Hortonworks gain came in the days following earnings due to Cloudera’s momentum in the stock market. A similar enthusiasm in Cloudera shares could be seen when Snowflake IPO’s in 2020.

Databricks IPO

There is talk of a Databricks IPO in 2020. Databricks is a SaaS business built on top of a bevy of open-source tools. Databricks recently raised a massive $400 million Series F round with a hefty $6.2 billion valuation.

Short Interest

~7.2% of Cloudera shares are held short currently. Over 20 million shares are currently held short which equates to ~4.5 x days of average daily volume. The amount of shares held short could amplify the effect of the catalysts mentioned if investors holding shares short are caught in a short-squeeze.

Share Buyback

Cloudera has ~$500 million in cash and cash equivalents (includes long-term investments) with no debt on its balance sheet. We project that Cloudera will generate >$100 million in free cash flow in FY 2021. These two dynamics allow Cloudera the ability to repurchase their own stock in a material manner. Given Cloudera’s discount to its peers, Icahn could encourage Cloudera to buyback stock in the near-term.

Risks

Execution

Execution is a double-edged sword for Cloudera. In the same way that execution could re-rate Cloudera upwards, a return in increased churn and an earnings disappointment could cause shares to decline. Management believes that most of the churn issues are behind them with the product road map is released, CDP being on schedule, and licensing changes should incentivizing those that have left Cloudera to return. Still, Cloudera could see unexpected disruption due to CDP being delayed or a few large customers phasing out CDP. If either of those things were to happen, Cloudera would undoubtedly see a share price decline due to renewed fears over the long-term health of the company. Another execution risk is CDP not generating material revenue from the outset. This is especially true of CDP public cloud. CDP public cloud utilizes a consumption-based model. Under the consumption-based model it may take time for revenues to ramp. Expectations about consumption-based revenue ramp needs to be carefully managed. The risk is that excitement for CDP is not met with an equivalent rise in revenues which could pressure the share price.

Guidance

It’s possible that Cloudera sets FY 2021 guidance that disappoints. Cloudera just introduced a new CEO and is also undergoing a massive strategic shift in the business. Management could choose to set expectations conservatively to where there’s an extremely high probability of exceeding their guidance. The disappointing guidance would likely cause a share pullback in the interim until subsequent quarters where Cloudera exceeds the baseline projections. A possible mitigant to this risk is a potential sales process. Cloudera doesn’t benefit from setting guidance too conservatively because it could hurt their sales process. Conservative guidance causing a share price decline would reduce the price that an acquirer pays for Cloudera. Realistically, Cloudera likely wants to set realistic guidance so that a sales process could command the highest possible sale price.

Cyclicality

Cloudera has a sticky customer base evidenced by the 6% churn rate for large customers ($1 million+), but there is cyclicality in revenue weighting between quarters. Q4 for Cloudera (ends 1/31/20) is by far the biggest quarter for revenue. This creates a backload for FY results and heightens the risk surrounding the Q4 earnings release. The backloaded nature of Q4 is mitigated by the revenue visibility that Cloudera usually has into at least the next quarter.

Cloud Adoption

We believe that certain workloads that are currently run on-premises would be better suited for the cloud and vice versa. Inherently, we believe in a hybrid-cloud future where Cloudera will be a major player. Even so, some firms may choose to move an ever-increasing number of on-premises workloads to the public clouds. If they had previously run these workloads with Cloudera, then Cloudera will be at risk of losing these workloads to public cloud providers or native-cloud companies like Snowflake. Cloudera will benefit from a hybrid-cloud future. However, if the future were to move primarily to public cloud with a small on-premises footprint, that would not be positive for Cloudera. Due to cost & security reasons, we don’t believe that’s the way the industry will move, but it is a risk nonetheless.

Competition

Cloudera is the largest if not only player in its immediate space after merging with Hortonworks and MapR was sold to HPE. Still, Cloudera has many competitors that double as partners that are far larger than itself. Amazon, Microsoft, Google, IBM, Oracle, etc. are all competitors. All these enterprises dwarf Cloudera when it comes to size and resources. Amazon notably has proven to be a huge competitor with its cloud-native applications within AWS. Competitors that create products that are either better or cheaper than Cloudera poses a risk that could have negative effects on Cloudera in the future. Additionally, the move of public cloud providers into on-premises could provide additional competition for a market that Cloudera currently dominates.

Technology Risk

New innovative technology could emerge that renders Cloudera’s products obsolete. This is somewhat mitigated by the shift to open-source within the industry, but it still remains a risk. Within open-source there is the risk that Cloudera could back the wrong product for its platform. Sometimes new technology proves to be a major disruptor to an industry (i.e. the internet disrupting newspapers). Other times new technology is no more than a fleeting fad. New technology remains a risk albeit an immensely difficult risk to quantify

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. I have no business relationship with any company whose stock is mentioned in this article.

Comments

[ThievesArmy]

Your articles are incredibly thorough, and I thank you for all your hard work. I also wanted to suggest you consider ASTS, which is another potentially asymmetric opportunity that I’m sure you could shine a big spotlight on if you chose to cover it. Thanks again

[Bjoshimd]

What a comprehensive and beautiful piece! A financial perspective tour de force. Thanks much.

[Profit Street]

I really enjoyed your indepth analysis of CLDR. I am long and agree with your thesis about the company and the current risk / reward situation.

[cristian chereches]

Congratulations and very appreciative of your work! It was more than a good read

[garysugarman]

Article as thorough as they come. This author's followers guidance looks very optimistic well into the future. One of my top purchases - in at $5.06 after "perfect storm". Nice bright spot in current storm.

[Steven Borovay, CFP]

Excellent article written before today's release and hit it right on with Icahn's requesting CLDR buyback shares. The potential red flags pointed out for the most part were squashed.

[Dy65]

Here’s an article that is spot on when looking back after the earnings report. Keep up the great work!

[tkonizzle]

One of the best articles I’ve read on Seeking Alpha. Truly encapsulates the entire story of Cloudera, including risks. Thank you very much for your insights.

[Carrengine]

Wonderful analysis. One of the most comprehensive I have read on Seeking Alpha.

[SivakumarA]

Great article with lot of content. will see the Q4 Earnings of CLDR in couple of hours.

[superman1235]

Nice article hope turnaround