Confluent (NASDAQ: CFLT) is an infrastructure software firm that offers managed data streaming and stream processing solutions via its Apache Kafka and Flink platforms. Kafka is an open-source software project that enables real-time data streaming between applications to massively reduce latency compared to batching and micro-batching techniques. Companies like Uber and FedEx leverage Confluent’s Kafka streaming services for real-time driver location tracking, while Flink Stream data processing is used in GenAI chatbots for low-latency monitoring and response to queries. Confluent, founded in 2012 by Kafka leaders, offers managed Kafka solutions split between on-premises and cloud environments, with both segments recording double-digit growth rates. Here, we summarized a bullish March-end thesis published by Mason on Value Investors Club.
A team of consultants in suits, discussing the importance of stream governance for real-time data.
The recovery of cyclical consumption spending and changes in the sales compensation model against derisked guidance complements CFLT’s secular product story of its new TAM-expansive Apache Flink offering. In March, the stock price was almost 25% off its trailing twelve-month highs and trading at a nearly 30% discount to industry peers. These factors, combined with the New Apache Flink product’s potential to boost Confluent’s cloud business this year, could offer room for the stock to rerate. The Flink protocol enables real-time computation of data streams between apps, and CFLT management thinks Flink’s total addressable market (TAM) is bigger than Kafka’s, which is estimated at $60 billion. While the leadership and sell-side analysts expect conservative to negligible contributions from the Flink segment in FY2024, internal surveys indicate that the new business is expected to lift Confluent’s cloud business spending between 15% and 35% during the current financial year before scaling further in the next fiscal. Furthermore, Flink’s major applications in GenAI chatbots related to data streaming and stream processing and the rapid adoption of AI chatbots across industries could translate to a material near-term tailwind for CFLT as streaming volumes intrinsically grow. CFLT also announced the acquisition of OpenAI as a client and a strategic partnership with Anthropic as part of broader efforts to capitalize on GenAI use cases.
Last year, CFLT management’s FY24 growth guidance was much lower than market expectations, at 22%, attributable to a few customers relocating AWS deployments from the cloud to on-premises, sales compensation model changes, slower-than-expected consumption, and its biggest customer being acquired by private equity. However, the company has demonstrated robust execution but retained its conservating FY24 growth rate, which likely doesn’t account for the sustained consumption recovery or material revenue from Flink. CFLT’s new sales model also shifts to paying sales representatives based on consumption revenue rather than contract bookings, which aligns with everyone’s interests. Sales representatives were previously rewarded for convincing customers to sign large contracts, as 85% of sales compensation came from bookings. Although the move presented revenue headwinds for CFLT and raised risks of sales attrition, management hinted they have already priced in these factors in their guidance and have yet to see any significant uptick in sales attrition.
It is important to note that CFLT has been gaining market share in the open-source Kafka segment and among hyper scalers offering managed Kafka services, given its enhancements in incremental functionality and total cost of ownership (TCO) savings. CFLT has a considerable runway ahead with a low 3% penetration or 5,000 customers in a market where 150,000 companies use Kafka services. Typically, open-source Kafka clients pay for CFLT’s managed offerings as they can save almost 60% on the total cost of ownership (TCO) while enjoying better performance. Understand that operating an open-source Kafka deployment needs employing Kafka engineers, which CFLT replaces at a lower price with its managed Kafka services. In March, CFLT was trading at almost 7.5X CY25 revenues, a three-turn discount to the estimated 10.5X average multiple of its rivals. CFLT’s focus on expediting topline growth, led by Flink’s contribution alongside an underrated margin story, which may reach long-term guidance above 25%, could also pave the way for multiple expansions.
CFLT is not on our list of the 31 Most Popular Stocks Among Hedge Funds. As per our database, 31 hedge fund portfolios held CFLT at the end of the second quarter, which was 37 in the previous quarter. While we acknowledge the potential of CFLT as an investment, our conviction lies in the belief that AI stocks hold greater promise for delivering higher returns and doing so within a shorter timeframe. If you are looking for an AI stock that is as promising as CFLT but that trades at less than 5 times its earnings, check out our report about the cheapest AI stock.
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Disclosure: This article was originally published at Insider Monkey.