Shares of data storage and data streaming disruptor Confluent (CFLT -4.90%) have been some of the hardest hit of the past couple years’ IPO stocks. Shares are down 71% since the bear market began in earnest at the beginning of 2022. But the tech stock sell-off actually started a couple of months earlier; since peaking on Nov. 5, 2021, Confluent shares have fallen almost 77%.
Confluent is like many of its high-growth, SaaS stock ilk that have fallen sharply. The sell-off started after a nearly two-year bull run following the 2020 coronavirus market crash, which saw many stocks reach extreme valuations. However, most didn’t have the fundamentals to support those prices.
Confluent is part of the group that’s been the hardest hit: companies that may be growing quickly, but are also burning cash. Over the past four quarters, Confluent has burned almost $170 million in operating cash while generating $537 million in sales. And that cash burn has been accelerating.
This has investors concerned; at some point, the company must show that it can generate positive cash flow to justify its existence as a stand-alone company. Moreover, Confluent has $1 billion in debt on its balance sheet now too, due in 2027. Investors see that debt, and see even more risk.
Frankly, the quick overview of Confluent above doesn’t paint the full picture. As a starting point, it went public specifically to raise capital to spend to take share and get to scale. Even with its recent cash burn, it ended the most-recent quarter with $1.94 billion in cash; that’s a lot of money to continue spending to grow the business.
You may be wondering: What about the debt? Yes, it’s there, but it also doesn’t cost the company any cash to service; it’s 0% — you read that correctly — so it gives the company a tremendous amount of flexibility. The risk it presents? Massive dilution, since it converts at a price of $100.06 per share, far higher than the recent per-share price of around $22.
But if management can continue to deliver high growth, and the economic model can start to turn from cash burn to cash generation, there’s a reasonable case that Confluent could preserve much of the cash it has today to pay down that debt. Moreover, four years is a lot of time for the story to change and the stock price to recover enough to make converting the debt into equity more palatable.
Investors today should focus on Confluent’s operational progress. Revenue was up 48% in Q3, while remaining performance obligations — revenue secured under long-term contracts it will recognize in future quarters — was up a massive 72%. Confluent Cloud revenue increased 112%, while its biggest customers continue to increase their usage of Confluent, and how much they spend.
There are some very serious, well-heeled competitors in the data streaming space, but Confluent’s founders built the open-source standard the company is based on. They’re the leading experts of the technology, and increasingly Confluent is the company other enterprises want to partner with. If management can demonstrate both the economic potential of the business mode and show some restraint in spending, today’s share price could prove to be a bargain.