In a tough economy, far fewer enterprise software companies are growing at strong double-digit rates compared with a couple of years ago. Confluent (CFLT 2.98%) is one of those companies. While there are a few reasons for investors to be hesitant, Confluent belongs on any growth investors' watchlist.
Data in motion
Think about any modern web service, comprised of many disparate systems across multiple clouds and data centers that need to communicate with each other in real-time, and it becomes clear that a powerful glue that holds everything together is practically a necessity.
Imagine a financial institution that processes transactions. When a customer swipes a credit card, a huge number of different processes may be kicked off behind the scenes, some dependent on others. There may be services to score the transaction for fraud risk, which likely require historical transaction data and other pieces of information. There may be services that send notifications, services that update data, and services responsible for calculating credit card rewards. New services may be added over time, and others may be removed.
If all these services directly communicated with each other, a disaster would be right around the corner. This type of architecture is fragile. If Service A goes down, what happens to the services that directly depend on it? They may go down as well, setting off a cascade of failures. Want to add a new service to the mix? You'll need to integrate it without accidentally breaking something else.
Confluent offers a solution to this problem. The company's platform is built on Apache Kafka, a popular open-source event streaming software. Confluent layers on proprietary features, removing much of the administrative and maintenance burden of running the complex piece of software. Instead of services pinging each other directly, Confluent's platform acts as a middleman. Some services publish data to Confluent, and other services consume data.
Confluent is having a lot of success winning enterprise customers. The company had nearly 4,700 customers at the end of the first quarter , and well over 1,000 of those customers contribute at least $100,000 to Confluent's annual recurring revenue. Here's the kicker: More than 150,000 organizations use Kafka. Confluent has only begun to scratch the surface of its total addressable market, which it estimates will reach $100 billion by 2025.
A stock to watch
Confluent expects to generate between $760 million and $765 million in revenue during fiscal 2023, representing growth of about 30%. Cloud revenue is expected to reach about half of this total by the end of the year as the company shifts toward its cloud-based solutions.
While Confluent is capable of growing at a double-digit rate for many years to come, there are two reasons why investors should stick the stock on their watchlist rather than buy it right away. First, the stock is extremely expensive. Based on the company's guidance, shares trade at a price-to-sales ratio of about 14.
Second, Confluent is not yet profitable or free cash flow positive. On $174.3 million of revenue in the first quarter of 2023, the company produced a GAAP net loss of $152.6 million and a free cash flow loss of $82.9 million. In both cases, losses grew from the prior-year period.
Confluent looks like a promising enterprise software company that could easily reach billions of dollars in annual revenue over the next five years. But investors may want to take a wait-and-see approach, given the lofty valuation and big losses.
