Most tech investors probably recognize Confluent (CFLT 2.92%) as the former cloud software division of LinkedIn that was spun off into a new company in 2014. It went public in June 2021, then more than doubled from its IPO price at the peak of the buying frenzy in growth and meme stocks near the end of the year.
But today Confluent's stock trades about 50% below its IPO price of $44. The stock plunged as investors fretted over its slowing sales growth, widening losses, and high debt. I recently discussed those challenges at length in another article, but today I'll focus on three other aspects of its business that also deserve your attention.
Image source: Getty Images.
1. Confluent is built on open-source software
Jay Kreps, Jun Rao, and Neha Narkhede initially developed Kafka as an open-source data streaming platform for LinkedIn's messages in 2011. It was also licensed and distributed through the non-profit Apache Software Foundation (ASF).
When Kreps, Rao, and Narkhede realized that Apache Kafka could also be used to process large amounts of streaming data for other companies, they founded Confluent with an investment from LinkedIn in 2014. Confluent's eponymous platform still ran on Kafka, but it was expanded into a more complete cloud-native platform for tracking "data in motion."
Confluent's open-source core makes it compatible with a wide range of computing platforms, but it also means its underlying technology can be freely used, licensed, modified, and distributed by its competitors. Many companies might prefer to run Apache Kafka for free on their own infrastructure instead of signing up for a paid "Kafka-as-a-service" provider like Confluent. Other cloud-based software companies can also easily license Kafka to develop their own competing platforms.
In its S-1 filing, Confluent says its primary competitors include "internal IT teams that develop data infrastructure software using open source software," and that its future success its "substantially dependent" on the "perceived viability, benefits, and advantages" of its platform compared to those open-source alternatives.
Furthermore, Confluent Cloud runs on a mix of Amazon Web Services (AWS), Microsoft Azure, and Alphabet's Google Cloud -- but all of those cloud platforms also provide their own first-party Kafka-as-a-service solutions that are directly integrated into their own cloud platforms. In other words, Confluent is ironically paying recurring infrastructure fees to some of its largest and most formidable competitors.
2. Confluent could benefit from the AI revolution
Confluent isn't often mentioned as an AI play, but analyzing the streaming data as it moves between applications -- instead of reading it from a centralized location -- can significantly increase the speed and efficiency of machine learning applications.
In its S-1 filing, Confluent said "many of the most powerful insights delivered by machine learning applications and systems depend on massive and continuous volumes of data in motion being processed, connected, and analyzed all at once," and that its platform could accomplish all those tasks to generate "greater actionable insights and recommendations."
Therefore, Confluent and its peers will all likely benefit from the secular expansion of the global AI market, which Grand View Research estimates will grow at a compound annual growth rate (CAGR) of 37% between 2023 and 2030.
3. Confluent's insiders aren't rushing for the exits
Confluent's stock is down nearly 50% over the past 12 months. But during that same period, its insiders bought 71.6 million shares while only selling 63.7 million shares. That warmer insider sentiment suggests the stock might be reasonably valued at 8 times this year's estimated sales. Back when Confluent reached its peak enterprise value of $23.7 billion in November 2021, it traded at 40 times the sales it would actually generate in 2022.
Do these factors make Confluent a more compelling buy?
Confluent expects its revenue to rise 30%-31% this year, decelerating from its 51% growth in 2021, and it will likely stay deeply unprofitable. Its high debt-to-equity ratio of 2 also makes it a risky buy as interest rates remain high.
Confluent could benefit from a growing need to crunch large amounts of streaming data for the AI market, but its open-source origins leave it exposed to a wide range of competitors. It's encouraging to see its insiders buy more shares even as its stock plunges, but I believe it needs to drop further before most investors consider it to be an undervalued growth stock.
