Shares of Confluent (CFLT -0.53%) have been hammered since its IPO in June 2021, down 54% from their IPO price and 78% from their all-time highs.
But these lows don't mean that the data streaming platform has flopped. In fact, it's seeing incredible adoption, likely because of its market-leading products. The company runs a managed Apache Kafka service, allowing enterprises to analyze data in real-time and at scale, which was not commonplace in the past.
Before Kafka, most data was processed on a daily basis rather than in real time. But many businesses want and need real-time insights into their data. The open-sourced Kafka platform allows businesses -- including more than 80% of the Fortune 100 -- to do this for free. The catch is that Kafka can be difficult to scale across an entire business, so Confluent -- which was founded by the same developers that created Kafka -- makes services more scalable, cost-efficient, and reliable than they would be if companies relied on Kafka alone.
Confluent is standardizing real-time data analysis, something that could be beneficial to nearly any business. Because of this, the company is seeing amazing adoption, and over the long term, it has the potential to be a much larger business than it is today.
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A mission-critical product
Analyzing real-time data is increasingly important for all businesses, and as a leading managed Kafka service, Confluent is well positioned to capitalize. The company doesn't see any direct competitors to Kafka in terms of developer mindshare or scope of usage, and the primary competition to Confluent is the self-developed Kafka solutions that businesses have. However, considering that the company continues to see impressive customer expansion, it looks like those businesses are switching to Confluent: The company now has over 4,100 customers, which grew 62% year over year in the first quarter of 2022.
Those customers are also increasing their usage. The company's net retention rate was over 130% for the fourth consecutive quarter, and remaining performance obligations (RPOs) jumped 96% year over year to $551 million in Q1. RPOs represent the amount that customers have committed to pay Confluent in the future, so high growth in this category signals that customers expect to lean on Confluent heavily going forward.
Confluent's secret sauce
Where Confluent really shines, though, is in its Confluent Cloud product, which is the company's cloud-native version of its managed service. Instead of installing software on a customer's own infrastructure and having that customer manage the platform on their own, Confluent Cloud is completely managed by Confluent itself and exists on -- you guessed it -- the cloud.
While Confluent Cloud currently only makes up 31% of revenue, it is growing like it could become the company's predominant revenue driver. Cloud brought in $39 million in Q1 revenue, which soared 180% year over year. The retention for Cloud customers is also incredibly high: Its net retention rate was over 150% in Q1.
Confluent Cloud adoption is being supported by incredibly large deals. In Q1, Cloud landed an eight-figure, multi-year deal, marking the largest in Confluent's history. This is another feather in the cap for the company, signaling its dominance in this industry.
A difficult road ahead
Despite all of this success, there are a few shortcomings. Notably, Confluent's profitability is not bright. The company lost more than $113 million in Q1, representing almost 90% of revenue. This has been decreasing, however. In the second, third, and fourth quarters of 2021, the company's loss margins were 99%, 93%, and 95%, respectively. Nonetheless, while Confluent's financials appear to be moving in the right direction, a 90% net loss margin still isn't pretty.
The company is also burning cash. In Q1, its free cash flow burn was over $58 million. Both of these loss figures are concerning, especially with the macroeconomic uncertainty in the market today. If a recession were to hurt enterprises, clients could decide to drop Confluent, which would result in stagnating growth. Still, Confluent had nearly $2 billion in cash and securities on the balance sheet at the end of Q1, which should keep it afloat for a while.
Confluent is a chance worth taking
Analyzing data in real time is becoming increasingly vital in a data-driven world, and Confluent is the top dog in this niche industry. While it might be a few years away from profitability, it could continue to rule the market for the next five years because of the advantages it provides when compared to in-house solutions. As more customers move to Confluent's solution, the company will begin to see its losses and cash burn turn around.
At 13 times sales, this company is not a screaming bargain. It is, however, the cheapest price investors have ever seen for this company since it went public, which is why it is especially appealing today. Because of such little competition going forward, I think that Confluent is poised to see mass adoption, and investors willing to take the ride might get compensated nicely.
