Confluent

Moat: 3/5

Understandability: 3/5

Balance Sheet Health: 4/5

Confluent is a data streaming platform that connects applications, systems, and data layers in real-time.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

Business Overview

Confluent is a cloud-native data streaming platform built on top of Apache Kafka, an open-source stream processing software. It helps organizations manage and utilize real-time data streams for various applications, including analytics, data integration, and real-time AI. It is designed to operate across on-premise data centers, hybrid and multi-cloud environments. They are trying to be the central nervous system of the organizations.

  • Revenues: Confluent’s revenue is primarily derived from subscriptions to their platform. This subscription revenue is recognized over time and is therefore considered recurring revenue. While the majority of the revenue is from subscriptions, they are also beginning to sell professional services to aid their clients in using the platform. They also have a small amount of revenue that comes from “Other” segment which typically consists of services rendered for their customers using their platform.

  • Industry Trends: The data streaming market is growing rapidly as businesses seek to leverage real-time data for better decision-making and improved operational efficiency. The rise of cloud computing, big data analytics, and AI are key factors driving this growth. There is increasing adoption of cloud data analytics platforms, which is one of their major growth levers. The need to process, analyze, and act upon data in real-time is becoming increasingly important for organizations, to optimize operations and decision-making. For the first time in their earning calls they mentioned that many customers are looking for companies that can help solve data problems end-to-end, rather than just focusing on point solutions. This means companies are moving towards integrated platforms for data infrastructure like Confluent.

  • Competitive Landscape: Confluent faces competition from both cloud-based offerings by companies like AWS, Azure, and Google, as well as companies that provide standalone Kafka solutions. However, they are increasingly seeing their differentiation be important to many customers, who are looking for one vendor for their data streaming needs across multiple cloud providers and on-premise locations, rather than a multitude of vendors providing point solutions and cloud infrastructures.
  • Differentiators: Confluent distinguishes itself through several key differentiators, mainly,
    1. Fully managed cloud-native service on all three major clouds (AWS, GCP, and Azure): unlike alternatives which are heavily reliant on specific cloud providers.
    2. A complete data streaming platform: instead of just an Apache Kafka offering, Confluent offers a complete end-to-end solution that includes all the features of a data streaming platform which other competitors cannot provide at the same scale. The platform provides high-level data abstractions and developer tools.
    3. Real-Time Data capabilities: which allows the company to process and react to events as they occur, with a robust, reliable, and scalable service.
  • Financial Highlights (Q3 2023):
    • Revenue is growing really rapidly, with 31% YoY increase. Confluent Cloud revenue is up 56%.
    • Remaining performance obligations (RPO) of $1.2 billion, growing 32% YoY.
    • Gross margin is 72%, Non-GAAP operating margin was 1.4%.

Moat Analysis: 3 / 5

Confluent’s economic moat is considered to be narrow based on the network effects derived from its platform, its high switching costs, and its open source model. A “narrow” rating indicates a discernible competitive advantage, but not one that guarantees very durable, long-term outperformance.

  1. Network Effects: The company’s core business model, based on the Apache Kafka open-source platform and the Confluent Cloud platform, has network effects. It is a great platform for open-source developers, and many software developers like to use open-source software. These combined effects create a solid community which has network effects.

    • Strength: The more developers and companies adopt Confluent, the more integrations are available and the more valuable the platform becomes.
    • Limitation: While Confluent’s ecosystem benefits from network effects, the platform is based on open source which means competitors can also create similar functionalities and use the same base code. This limits the durability of this competitive advantage.

  2. Switching Costs: Confluent’s platform is integrated into their customers infrastructure and systems, therefore switching to a new service is costly and disruptive for the customers. This results in high customer retention, and customers tend to stay with them for a long time.

    • Strength: Once a company has integrated Confluent’s platform, they are unlikely to switch due to high implementation costs and effort. Also the financial costs of converting to a new system is really high and so most customers would stick with them.
    • Limitation: Confluent’s switching costs are higher for larger enterprises and are not present for every customer, for example mid and small size companies are likely to be less sticky.

  3. Proprietary Technology & Innovation: The company does have unique technology and has been an innovator for stream processing and data management. With expertise in Apache Kafka, they also have unique knowledge about how to optimize it, and create their platform.

    • Strength: Their cloud offering is unique and is based on all major cloud providers.
    • Limitation: Open-source technology base means many competitors can and do replicate their functionalities at a very high rate. For now Confluent is differentiated, but it may erode with time.

  4. Scale Advantages:

    • Strength: Confluent has amassed a huge amount of resources, they have access to a massive base of engineers, developers and sales force.
    • Limitation: Scale does have its limitations and does not affect all industries equally.

Risks to the Moat & Business Resilience

Despite Confluent’s competitive advantages and rapid growth, here are some of the risks that could negatively impact the company:

  • Intense competition: Confluent operates in a competitive market with established players like AWS, Azure, and Google, as well as emerging tech companies. This puts pressure on pricing and market share. Additionally, commoditization of products can increase the rate of new entrants in the market. They also face competition from vendors that offer point solutions for specific data analytics processes.
  • Technological Disruption: Being a tech company, they also face the risk of new technology disrupting their business model or making their offering obsolete.
  • Cloud concentration: Currently Confluent’s cloud platform runs on AWS, Azure and GCP. Any disruptions or problems associated with those cloud providers can also hurt Confluent.
  • Economic Downturn: Although cloud spending is expected to be resilient to a recession, a recession could mean fewer new clients, reduced spending, or project cancellation.
  • Dependence on Apache Kafka: Since the company is based on Apache Kafka open source software, dependence on it carries some amount of risk.

Despite these risks, there are a number of factors which show resilience:

  • Recurring Revenue: The subscription-based business model leads to predictable revenue streams, which helps insulate the company’s performance from market turmoil.
  • High Retention: Customers are reluctant to switch because of high switching costs.
  • Strong Balance Sheet: The company has more than 1.8 billion in cash and short-term investments. This allows the company to spend more money on growth, and ride out downturns.
  • Strong Growth Trend: The trend of data and analytics growing means increasing adoption of their product, leading to continued organic growth.

Financial Analysis

Confluent’s financials show a strong growth trend, with revenues increasing rapidly year-over-year, due to increasing demand for its subscription-based platform. However, their losses are also increasing significantly due to growth investments in sales and marketing.

  • Their gross margins are high, indicating a good pricing power.
  • They have a lot of cash which gives them the ability to ride out a recession, and also aggressively grow their business.
  • They have no debt.
  • They have high growth rates.
  • Their profitability is still below par.

Understandability: 3 / 5

Confluent’s business is of moderate complexity.

  1. Technology Understanding: Understanding the software technology is relatively complex and may require a more in-depth understanding of data streaming technology.
  2. Business Model: Although the subscription model is straightforward, the specific ways they monetize their business and the full capabilities of their platform are not fully known by many.
  3. Industry Dynamics: Understanding their place in the competitive landscape and which specific features differentiate them from competitors is important, but is relatively tough.

Balance Sheet Health: 4 / 5

Confluent’s balance sheet is generally healthy, but not without some points to consider.

  1. High Cash Levels: Confluent has a lot of cash, around 1.8 billion dollars in cash and marketable securities. This means that they are able to fund future growth, acquisitions, and also are protected if the market goes sour.
  2. No Debt: The company has no debt, which indicates the balance sheet has little leverage.
  3. Increasing Negative Working Capital: While inventory isn’t a concern for Confluent, their accounts payable have been growing quite rapidly, outstripping their receivable, indicating a reliance on credit for suppliers.
  4. Rising Deficit and Stock-Based Comp: While their losses have been rising, they have been due to significant investment in the business, which is a good sign. However, their Stock-based comp has been significant in the past, but the rate of increase has started to slow.

In conclusion, Confluent is a growing company with a unique and leading position in its industry. It has a narrow moat due to network effects, high switching costs, and proprietary technology. It has a solid balance sheet, and the company has a significant growth runway ahead, as it is increasingly recognized as a core component of their customers tech stack.