- CFLT is a recent tech IPO that has debuted with great fanfare.
- "Data in motion" appears to be mission-critical infrastructure for today's data-driven economy.
- CFLT generated 67% revenue growth in the latest quarter.
- I examine the valuation and discuss if now is the best time to buy into the stock.
- Looking for a portfolio of ideas like this one? Members of Best Of Breed get exclusive access to our model portfolio. Learn More »
Confluent (NASDAQ:CFLT) came public this year and quickly joined the ranks of high-flying tech stocks defined by explosive growth and an equally explosive stock price. Yet, do investors know what they are buying? In this article, I break down CFLT's business model and evaluate the stock at the current valuation. While CFLT appears to have a promising growth outlook, I question whether the stock is a bargain at current prices. Prospective investors are likely to get better entry points after the IPO lockup period expires later this month.
CFLT Stock Price
CFLT is a semi-recent IPO, having come public just in late June. As typical in today’s market, CFLT was greeted with great enthusiasm as it closed its first day of trading at $45 - 25% higher than its public offering. At one point, the stock almost fell down near the public offering price, before rallying back close to all-time highs:
At recent prices, the stock is trading over 100% higher than its public offering price. Is it a buy? Let’s look deeper at the business.
What is “Data in Motion?”
CFLT believes that it is creating a new category in data infrastructure called “data in motion.”
Don’t know what that means? Don’t worry, yours truly also did not immediately understand the meaning either. Let’s start from the beginning. Databases are needed to store data - every image, every webpage, every user is stored in a database. The typical database model is like the one seen below:
Databases might be queried against while updates happen slowly - often daily via batch processing. That isn't going to work when data is created on the fly and needs to be used instantly.
There’s yet another problem with this model. There might be many applications trying to access a database. Or there might be apps from different business categories trying to access a database. The net result is that the typical data architecture may look messy like below:
The above architecture would require developers to write a significant amount of code just for all the different access points for the databases, and all the different requests from the apps. As seen above, it can get out of hand very quickly. Enter CFLT: it acts as a central nervous system for all apps and databases:
In contrast with the previous data architecture, all databases and apps need to merely communicate with one entity - the central nervous system. Developers no longer need to code for every single access and request point. This kind of architecture makes reading and writing data much faster. There are countless use cases across all industries which require real-time “data streaming.”
We can see some of the customers below:
This kind of architecture is powered by Apache Kafka - a free open source platform. CFLT theoretically makes it easier and better for customers to implement Apache Kafka. CFLT estimates that 70% of the Fortune 500 are currently using Apache Kafka.
Want more? This video explains Apache Kafka quite well.
We have seen what CFLT does, and it is clear that their business model is highly compelling in today’s data-driven world. CFLT estimates a rapidly growing market that may reach $91 billion in 2024:
CFLT has reported strong revenue growth, averaging 90% through 2020:
Most of that growth has been driven by rapid growth in customers:
In the latest quarter, CFLT generated 67% revenue growth. Remaining performance obligations grew by 75% - which suggests that future quarters should remain strong as well.
Gross margins are strong at 70%, but I expect there to be some volatility moving forward as CFLT shifts more of its business towards cloud revenue.
Tech companies like CFLT typically generate lower gross margins from cloud on a small revenue base but dramatically improve on that margin upon greater scale. Currently, 26% of overall revenues are on the cloud.
Valuation and Price Target
CFLT has a great business and is growing rapidly, but I am not buying. At recent prices, the stock trades at a blistering 67x trailing revenues. CFLT trades at 55x 2021e revenues:
The problem with richly valued stocks is that even if they generate strong growth, it might not lead to strong shareholder returns. Wall Street is expecting 35% revenue growth over the next 2 years. CFLT isn’t looking attractive at nearly 30x 2023e revenues, which suggests that the stock could stand still for 2 years and still be overvalued.
Perhaps you think that consensus estimates are too conservative? Let’s assume that CFLT sees 50% 2022 revenue growth and 40% 2023 revenue growth, followed by 34% 2024 revenue growth. CFLT would be trading at 26x 2023e revenues. Even with the adjusted forecast, CFLT still isn’t looking that cheap if we buy today.
I’d be more interested in buying if CFLT traded around 25x 2021e revenues or lower, which would place the stock at $36. Clearly, the stock has a lot of room to fall to get to my preferred entry point.
CFLT deserves a lot of the hype it has received since coming public, as its technology will likely only prove more and more important as the world becomes more and more reliant on data. Due to overvaluation, buying today would not lead to strong investment returns. It is preferable to wait for better prices, perhaps when the IPO lockup expires around December 21st. I also mention that one could potentially couple any purchases with covered call options. In particular, the December 2022 expiration $140 strike is selling for around $10, which would help reduce the cost basis by nearly 13% while allowing for 100% upside from there. While the options premiums are quite generous, they are likely reflective of the likelihood that the stock remains too richly valued in its own right.
This article was written by
Julian Lin is a financial analyst. He finds undervalued companies with secular growth that appreciate over time. His approach is to look for companies with strong balance sheets and management teams in sectors with long growth runways.Julian is the leader of the investing group Best Of Breed Growth Stocks where he only shares positions in stocks which have a large probability of delivering large alpha relative to the S&P 500. He also combines growth-oriented principles with strict valuation hurdles to add an additional layer to the conventional margin of safety. Features include: exclusive access to Julian's highest conviction picks, full stock research reports, real-time trade alerts, macro market analysis, individual industry reports, a filtered watchlist, and community chat with access to Julian 24/7. Learn more.
Analyst’s Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such 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.
Seeking Alpha's Disclosure: Past performance is no guarantee of future results. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. Any views or opinions expressed above may not reflect those of Seeking Alpha as a whole. Seeking Alpha is not a licensed securities dealer, broker or US investment adviser or investment bank. Our analysts are third party authors that include both professional investors and individual investors who may not be licensed or certified by any institute or regulatory body.