Confluent (CFLT -1.90%) reported its fourth-quarter earnings results on Feb. 10, blowing past analyst expectations. The company made $120 million in revenue, which topped estimates by $10 million. It also reported a less-than-expected net loss of $0.19 per share. Management continued to impress with guidance for first-quarter revenue of $118 million, representing growth of 53% year over year.
Despite these strong results, share prices of Confluent fell more than 21% after reporting, likely because of the company's high valuation: It traded above 40 times sales going into the quarter. With high valuations like that, sometimes beating expectations simply isn't enough.
But the share price drop might be a great buying opportunity for investors. The company is still in hypergrowth mode, and it is seeing lots of success expanding into the very lucrative cloud space. With risk being mitigated by Confluent's worldwide adoption, the future looks promising, which is why I see it as a buy today.
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Confluent tries to help companies "set data in motion" by providing software to manage and analyze data in real-time to react to information instantaneously. Apache Kafka is an open-source project used by 80% of the Fortune 100 and thousands of companies worldwide, and it allows companies to analyze data in real-time.
It can be incredibly hard to efficiently manage the Kafka platform and scale it across an enterprise, but Confluent can help businesses do this. As the leading managed Kafka service, Confluent is being rapidly adopted as companies recognize how hard it is to run this mission-crucial service themselves.
All of this underscores three reasons Confluent stock could be a buy.
1. It's a hypergrowth company
This major adoption has led to great things for Confluent. The company grew revenue 71% year over year in the fourth quarter, and its remaining performance obligations (RPOs) jumped 91% year over year to $500 million. RPOs represent contracted revenue that customers expect to spend in the future, and RPO growth has accelerated the past four quarters.
Confluent also added 450 customers in the quarter while accelerating its net retention rate, so its customers seem to be churning less and spending more. This quarter, the net retention rate reached 130%, meaning that on average, customers spending $100 last year are now spending $130.
The company is not profitable or free-cash-flow (FCF) positive, but it's mitigating this. It lost $343 million in 2021, a high figure considering it only brought in $388 million in revenue, but its FCF paints a better picture. In 2021, FCF was negative $114 million, but this only grew 31% year over year, much slower than the 64% top-line growth in 2021. With over $2 billion in cash and securities on its balance sheet and no debt, Confluent can remain unprofitable but still expand its growth segments for a long time.
2. A cloud-centric approach
One of the major areas the company is investing in right now is the cloud. Confluent has many premise-based enterprises as customers, but it is looking to ramp up its cloud-based product, and has done this well. Cloud revenue grew 211% year over year to $34 million in the fourth quarter, making up 28% of revenue.
The company thrives on its cloud-native solution, but its major adoption is driven by the fact that Confluent can operate efficiently both in the cloud and on the on-site platform. Management sees both strategies as part of its success, with its cloud solution eventually becoming the primary source to attract and retain customers, considering that cloud revenue makes up half of its bookings.
One downside to Confluent cloud's success is that it impacts the company's gross margin. Cloud is a younger product, and it has lower margins today. Total gross margins in the fourth quarter were 61.5%, which fell from 70.3% in the year-ago period. However, management said it thinks that as the cloud segment scales up, its gross margins will improve and total margins will reach the company's long-term goal of 70%.
3. International adoption
Confluent is gaining adoption in a market worth $50 billion today and which is expected to grow to $91 billion by 2024. This major industry growth means that if Confluent can solidify itself as the main Kafka management service today, it could benefit immensely over the coming decade.
Besides partnerships with Snowflake and Amazon in the U.S., Confluent has also partnered with Alibaba Group Holding to bring its services overseas. With 38% of its revenue from international customers, it's in a position to capitalize on this major market opportunity.
Aside from the company's high valuations, which sunk from over 40 to 32 times sales after its big drop post-earnings, Confluent has everything going right for it. The company's FCF burn is shrinking compared to revenue growth, and its gross margins will likely start to turn around in 2022. It is hard not to see Confluent as a screaming buy, and I plan to add to my position in the coming months.
