Thinking about investing in Confluent (CFLT -0.73%) stock in 2022? In this segment of Backstage Pass, recorded on Jan. 10, Fool contributors Jamie Louko and Danny Vena discuss the fast-growing software-as-a-service (SaaS) stock and what potential investors need to know about the company's innovative business model.
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Jamie Louko: I'm going to be talking about Confluent. To put it really simply, their mission is to set data in motion. That basically means with businesses creating so much data nowadays, most of them just send their data rate to a data warehouse but with a lot of businesses like, let's take banks for example. Some of that data shows that there was potential fraud. They really need to realize that data in real time, and Confluent allows them to do this. There is an open-source project called the Apache Kafka.
That is the kind of the brains behind all of this that allows companies to analyze their data in real-time. But the problem with Kafka is that it's really hard to scale and integrate into an entire enterprise. This is basically what Confluent does. They manage the entire Kafka service for business and they basically scale it into their entire enterprise. As you can see down this bottom picture, they have some really big customers. Home Depot, Domino's, Netflix, Unity. They have a lot of really big-name customers. Eighty percent of the Fortune 100 use Kafka and 70% of the 500 use it.
There is definitely a big pool of large enterprises for Confluent to take here. The major highlight for Confluent is that the developers of Kafka, which is an open-source and free solution were also the founders of Confluent. Jay Kreps, which is the CEO of Confluent today. He was one of the developers of Kafka and he made it open-source, he made it free for everybody, but then realized the problems of the scaling and so he, along with the two other developers, founded Confluent.
This has resulted in a bunch of growth: 58% top-line growth for the trailing 12 months. Confluent Cloud, which is the cloud-based service for Confluent, grew 245% in Q3 and we can see that it's a pretty small amount compared to total revenue.
A lot of Confluent is an on-premise software but we can see that it is growing rapidly.
Since Q4 of 2019, revenue has grown sequentially every single quarter, net retention rates super strong at 130%. Their market is growing massively. It's expected to nearly double in just a few short years.
Danny Vena: For those folks who may not be familiar with net retention rate, that's essentially of the same group of customers and they essentially have spent 30% more this year compared to what they spent last year, right?
Louko: Yes. Thank you, I should have clarified that.
Vena: No problem.
Louko: Thank you very much Danny. But like every other IPO, it's not profitable, it's very expensive. I don't like that they have a negative free cash flow and it's pretty substantial.
I'm not a fan of that. The other thing that has been a downtrend as of late in the past three or four quarters, and the gross margin has declined.
That is mostly because of the rapid growth of Confluent Cloud which has a pretty poor gross margin right now, but it is seeing signs of improving rapidly as they get to scale on that, and just a few minutes, that is Confluent.
Vena: Well, thank you for that detailed look at Confluent. You know, this is a company that I've looked at and I just don't quite understand the business enough yet, where it's one that I would be willing to put my own money into.