Data in motion and real-time AI may propel this stock much higher
Thomas Johannes Look
Capital Management (up 41,75%+ in H1 2024, up 23,17%+ in H2, since 1 July 2024), Corporate Advisory & Digital Publishing
Three pieces of background
(1) There are three states of data to categorize structured and unstructured data: (a) data at rest, (b) data in motion, and (c) data in use. Data at rest is all data in computer storage that is not currently being accessed or transferred. Data in motion is data that is moving or being transferred between locations within or between computer systems. Data in use is data that is currently being updated, processed, accessed, and read by a system.
(2) Apache Kafka is an open-source stream-processing software platform developed by Linkedin and donated to the Apache Software Foundation. It is designed to handle real-time data feeds and operate as a distributed event streaming platform. Kafka provides fault tolerance, scalability, and a unique publish-subscribe model, which can be used for stream processing and message queuing. It's particularly well-suited for handling large volumes of real-time data, making it popular among enterprises for tasks like log aggregation, data warehousing, real-time analytics, and mission-critical applications.
(3) Apache Kafka was originally developed at LinkedIn by Jay Kreps, Neha Narkhede, and Jun Rao. After its creation, LinkedIn later donated Kafka to the Apache Software Foundation, where it became an open-source project. The three co-creators of Apache Kafka founded Confluent in 2014. Confluent (CFLT) went public in 2021 during the hypergrowth stock craze on NASDAQ.
Confluent in a nutshell
Confluent is a platform dedicated to data in motion, specifically to stream processing and real-time data. There are two key product offerings:
Confluent Platform: A more complete distribution of Apache Kafka with additional tools and capabilities to enhance the streaming experience for large enterprises.
Confluent Cloud: A fully-managed event streaming service based on Apache Kafka, allowing businesses to harness the power of real-time data without the operational burden.
Market Position, competitive landscape, and use cases across industries
With data becoming increasingly crucial in real-time decision-making processes for businesses, the demand for platforms like Confluent's is rapidly growing.
While other players are in the real-time data streaming market, Confluent's deep ties to Apache Kafka give it a unique edge.
The demand for real-time, low latency data streams from AI, IoT, Adtech, Autos, and more will increase meaningfully in the future, and Confluent has the best cloud platform to constantly stream such data at scale, enhance, maintain, and provide analytics for it.
Heavyweight competitors, mainly Amazon's AWS, Microsoft's Azure, and Alphabet's Google Cloud, have their own managed data streaming products, as do some legacy on-premise providers such as Tibco Streaming, Red Hat, part of IBM, and Oracle.
Open-source Kafka remains the free alternative for small and medium-sized enterprises and selected use cases.
However, none have the focus, scale, rich features, implementation, integration, support, and cost savings that Confluent's agnostic platform can offer.
Confluent serves all markets - cloud, hybrid, and on-prem with a business focus on their cloud native subscription platform, which has been growing at an annual rate of 83%, providing sustainable and recurring revenue streams.
What makes Confluent stand out?
Best in Class Product: Even though AWS, Azure, and Google Cloud are strong competitors, they don't have the core functionality or rich features, integration, and breadth that Confluent does. A Comparison of the products (Amazon MSK vs. Azure Event Hubs vs. Confluent vs. Google Cloud Dataflow) showed 26 integrations for Confluent versus 9 and 10 for the rest, much wider deployment, and more robust support and training.
Integrated Data Streaming Platform: CFLT management outlined several new aspects and growth drivers during the latest earnings call, and the build-out of a comprehensive DSP (Data Streaming Platform) stood out.
With Kafka as the foundation, the DSP does much more than stream data. It uses five integrated streaming processes: connecting, governing, processing, and sharing. All these components, including the non-Kafka ones, can be monetized, and Confluent has started Freemium licensing/subscriptions to increase engagement and revenue.
Using Apache Flink (a recent acquisition) also increases engagement and monetization for stream processing, governance, and sharing from customers like Netflix and Instacart. Revenue from the Stream Governance Advanced Offering was their fastest product grower ever. The stream processing offering should be available in 2024. The stream-sharing offering will be valuable to the finance, insurance, and travel insurance industries, which must share data with providers and customers.
Confluent use cases - two examples
Here are two examples from C.E.O. and Co-Founder Jay Kreps from the Q2, 2023 conference call, highlighting how best to use Confluent:
Meesho is a high growth Indian e-commerce company who last year was one of the most downloaded shopping apps in the world. It was the fastest shopping app to cross 500 million downloads and regularly sees huge traffic spikes that see over 1,000,000 requests per second. Kafka is used broadly across Meesho's business including its real time recommendation engine to deliver great user experience for customers and sellers. But manually configuring and tuning open-source Kafka wasn't aligned with their overall push for sustainable solutions and driving business efficiencies. So, they migrated to Confluent Cloud. Confluent now processes its shopping transactions and is a key part of the architecture that delivers exceptional experiences for its buyers and sellers.
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Recursion Pharmaceuticals is a leading biotech company that uses advancements in AI and biology to accelerate and industrialize the discovery of new drugs. Traditional drug discovery is often slow and expensive, relying on manual bespoke processes and experiments influenced by human bias. Recursion, on the other hand, runs over 2 million experiments per week to generate a massive biological and chemical data set to train machine learning models that discover new insights beyond what is known in scientific literature. Confluent is the backbone stream infrastructure for experimental data that feeds their AI models, with more than 23 petabytes of real time biological and chemical data improving the predictions of the models.
Confluent and AI
The Confluent platform is exceptionally well-suited for various applications in the AI domain, including generative artificial intelligence (Gen AI) and other specialized AI applications. Use cases of how the Confluent platform can be integrated into AI workflows entail:
The Confluent platform is the backbone for many AI applications, ensuring that data is reliably and timely available for AI models to function effectively in real-world scenarios.
Example of using Confluent for a real-time travel guide
Integrating the Confluent platform into a real-time travel guide can significantly enhance the user experience by providing timely, relevant, and context-aware information.
Real-time Travel Guide with Confluent Platform:
By leveraging the Confluent platform, a real-time travel guide can offer travelers a highly responsive, context-aware, and enriched experience. Such dynamic information delivery can transform how travelers interact with their surroundings, making their journey more engaging, safe, and informed.
Financials
Confluent showed excellent growth in the first half of 2023. All the essential metrics were solid.
Revenues grew 37% YoY, aided by massive growth in cloud platform revenue of 83%. The cloud platform is the backbone of the business, getting sustainable and recurring subscription revenue.
Confluent employs a great SaaS land and expand strategy with 130% Net Revenue Retention (NRR) and a gross retention rate of about 90%. The cloud platform has an NRR of 140%.
On-premise license revenues also rose positively, with growth north of 16%.
The other big plus was the margin improvement, with single-digit improvements in gross GAAP and adjusted margins, resulting in a 50% improvement in adjusted operating losses.
Currently, the adjusted OPM is down to -16%, and Confluent has guided to -10% for 2024, promising to break even on an adjusted basis in Q4. In a choppy and challenging environment, focusing on reducing costs is crucial, and for the first half, the most significant improvements came through lower sales and marketing expenses.
Confluent is far from GAAP positive with a humongous $171Mn of Stock-Based Compensation in 1H2023, nor is it generating operating cash - but it is a step in the right direction.
Large clients over $100,000 in ARR also grew well with a 33% YoY increase, as did the 147, over 1 $Mn clients with an even more impressive 48% growth.
Buying the dip
As of writing (October 18, 2023), the stock is around $30 after briefly reaching $40-$41 during the AI hype in July. Confluent's first-half performance confirmed the positives of the company. It's worth buying for the long run.
Valuation: The forward P/S ratio is over 9 (quite average for a hypergrowth SaaS company), with high growth of 33%, bringing it down to 7 and 5. Patience will pay off, and given the Fed's higher-for-longer stance and with 10-year treasury yields over 4.9%, valuations are stretched across the board.
I would buy between $27-29. There may be a 10-15% drop from current levels. Confluent is well suited for a covered call strategy. Option premiums are high. Buying below $30 and selling calls - strike $35 or $40 - makes much sense.
The following earnings report is just around the corner. Initial guidance for 2024 may have a significant influence on the stock.
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