The 2022 initial public offering (IPO) market has cooled off substantially from the craziness of 2021. A study from Dealogic found that there has been just $6.9 billion in funds raised by IPOs so far this year, which is 83% less than at the same time in 2021. This has likely been due to the immense volatility seen in public markets, which makes it hard for companies to value themselves at a price the market would like.
With few stocks coming public in 2022 so far, it might be smart to look back at some of the high-quality companies that came public in 2021. There were dozens of high-profile names that made themselves available to investors last year, but one under-the-radar tech stock stood out because of its market dominance and the fact that its product is a necessity for many businesses.
Here's why Confluent (CFLT 1.23%) is one of my favorite 2021 IPOs, and why I think it is worth buying right now.
Image source: Getty Images.
Bringing real-time analysis to scale
For the majority of businesses, the data they receive from their business operations and applications goes straight to a data warehouse, where it is analyzed over the following days. However, millions of businesses need to analyze their data in real time to work effectively. An open-source platform called Apache Kafka can allow them to do this, and it is used freely by thousands of enterprises, including 80% of the Fortune 100.
The problem with Kafka is that it is very difficult to scale across an entire enterprise, meaning that many users only use Kafka in a small segment of their business. Streamlining data analysis across a business is challenging, and that is where Confluent helps. The company acts as a managed Kafka platform to help businesses scale and use Kafka more effectively.
Importantly, the founders of Confluent were the original developers of Apache Kafka, so nobody knows Kafka better than they do. This gives them a leg up over other companies trying to build managed Kafka systems. With its knowledge advantage, Confluent has become the leading platform in the industry with over 3,470 customers.
A fast-growing market awaits
The company looks to help all Kafka users, and with thousands of them -- many of them among the biggest enterprises in the world -- Confluent is fishing in a large pool. It is growing revenue like gangbusters, reaching $120 million in revenue in the fourth quarter, a 71% jump from a year ago. Its number of big customers is also skyrocketing: 734 customers spend over $100,000 annually with Confluent, and that figure grew 43% from a year ago.
Confluent Cloud is where the company sees a major opportunity. Many enterprises that currently use Kafka do so on their own, in-house platforms rather than the cloud. However, the cloud allows businesses to be even more efficient, so Confluent is looking to move Kafka customers to a cloud-managed service. Confluent Cloud revenue grew 211% year over year to $34 million, showing the company's great success with this endeavor.
The combination of Confluent Cloud and the underpenetrated base of Kafka users that don't use Confluent has given management a lofty addressable market to tackle. The company believes its opportunity will reach $91 billion by 2024 -- almost doubling from 2020.
Investing heavily in the future
The company is investing heavily to make sure it can capture the benefits of the market ahead. To make Confluent Cloud adoption easier for its customers, the company has diminished its short-term margins for that business. Therefore, its total gross margin has taken a hit. The company's Q4 margin was 62%, down 70% from the year-ago quarter. However, as Confluent Cloud continues to scale, the company believes it will reach its long-term goal of 70% gross margins.
Confluent is also building out a team to help businesses adopt and use its products more easily. This investment will likely result in long-term adoption for the company, but in the short term, it's hitting Confluent's profitability. Free cash flow in 2021 was negative $26.5 million, and the company's net loss for the year represented 88% of revenue.
Why I am buying Confluent
While the company's profitability might be lacking today, it is undeniable that Confluent is gaining market share. As the leader with unrivaled knowledge expertise, it could continue doing so -- and as the company grows, its profitability and free cash flow will likely follow.
The shares are down 50% from their all-time high, and now roughly flat with the IPO price when it came public in June 2021. The company trades at 26 times sales, however, which is down substantially from its valuation at that time. With these all-time low valuations, the company looks like it could bounce back and become a market-beating investment over the next decade.
