Cloudera: Plenty Of Upside As The Company Turns A New Page – Cloudera, Inc. (NYSE:CLDR)

If there’s one stock that technology investors love to hate, it’s Cloudera (CLDR). The open-source Hadoop company has been one of the most unsuccessful IPO stories of the past few years, with the stock down about 20% from its IPO price of $15 in mid-2017. Compare that to its open source cousin MongoDB (MDB), which went public a few months after Cloudera and to date has quintupled since its IPO.

In light of how cheap Cloudera’s stock now is, it’s a good time for investors to review the bullish thesis for this stock. Recall that Cloudera’s all-stock merger with Hortonworks (HDP) closed earlier in January, and will start reflecting into Cloudera’s results next quarter. Aside from creating the most dominant, integrated vendor of Hadoop software in the market, the addition of Hortonworks’ revenues will also help mask Cloudera’s revenue deceleration into the mid-20s. Looking longer-term, as data volumes explode and use cases evolve, complex data processing and management tools like Hadoop will only become more prevalent. In short, a combined Cloudera-Hortonworks has plenty of runway for growth.

Data by YCharts

Investors would be wise to pick up shares of Cloudera while it’s still cheap.

Cloudera has seen grim phases before – it’s just a conservative forecaster

One of the biggest issues plaguing Cloudera’s stock right now is the perception of weak guidance for FY20. Alongside Cloudera’s fourth-quarter results released in mid-March, the company also issued the following outlook:

Figure 1. Cloudera FY20 guidanceCloudera: Plenty Of Upside As The Company Turns A New Page - Cloudera, Inc. (NYSE:CLDR)Source: Cloudera Q4 press release

The 76% y/y revenue growth implied in the $835-$845 million revenue range appears impressive, but recall that this will be the first full year of folding in Hortonworks’ results. Analysts, on the other hand, had expected far stronger revenues at $942.2 million, or +96% y/y.

Given the gap between guidance and expectations, it’s not difficult to understand why Cloudera’s share price trimmed nearly 25% on the news. It’s important to recognize, however, that accounting quirks contributed to the lion’s share of this downside guidance. CFO Jim Frankola noted on the Q4 earnings call that deferred revenue recognition for Hortonworks post-merger close acts as a $62 million headwind to FY20 revenues – more than half the gap to Wall Street’s expectations.

If we strip out this accounting headwind, which has little bearing on fundamentals, the true miss to Wall Street’s FY20 expectations is approximately only $40 million, or ~5%. We note, however, that Cloudera has been in this situation before. Around this same time last year, Cloudera management issued FY19 guidance at $435-$445 million, citing sales execution issues and difficulties renewing large clients.

At the time, shares of Cloudera had tumbled nearly 30% on the news as well. Yet Cloudera finished out the year with $479.9 million in revenues – nearly 10% above the high end of its initial range, and $40 million above the original midpoint of its range. It also managed to generate $34.3 million in operating cash flows, unlike many other SaaS companies that are burning cash.

This year’s revenues are bound to be more unpredictable due to the closing of the Hortonworks merger. The company is likely still working out how to best integrate its sales teams and re-organize its go-to-market strategy. Cloudera’s visibility into this year’s revenues is much lower than last year, where it had known renewal/organizational issues. As such, the company is guiding conservatively – but history shows that Cloudera typically comes out on top.

Recurring revenues continues to grow at a steady pace

Another critical piece of the bullish thesis for Cloudera is that it’s a recurring revenue behemoth. Of the nearly $1 billion in revenues that the combined Cloudera-Hortonworks is projecting to generate in FY20, the lion’s share of it is renewable.

Cloudera and Hortonworks take different approaches to subscription software. While Cloudera’s software wraps proprietary elements around an open-source core and charges for it like a traditional SaaS company, Hortonworks instead sells support contracts to customers using open-source Hadoop software. Regardless, both business models have high recurring potential.

In Cloudera’s most recent quarter, the company managed to grow ARR at 24% y/y; and its FY20 calls for 18-2% y/y growth. Tom Reilly, Cloudera’s CEO, notes that a combined Cloudera-Hortonworks has greater potential for expansion within the current installed base due to cross-selling opportunities. Per his comments on the Q4 earnings call (key points highlighted):

On a combined company basis, adjusted ARR grew 24% year-over-year. Cloudera now has the scale of resources to address the growing opportunity in large enterprises. We began the fiscal year with more than 2,000 enterprise customers, less than 10% of those customers have broadly adopted our platform reflected an ARR greater than $1 million, while there’s still significant upside in those large customers. The key takeaway is that more than 90% of our customer base is right for expansion via the enhanced up sell and cross sell motions enabled by the merger.”

Though growth at both Cloudera and Hortonworks has certainly slowed down, the fact that most of its revenue base is recurring sets up a strong foundation for future profits, especially as the merger is expected to eventually produce $125 million in annual cost synergies.

Note also that Cloudera’s revenue mix has been constantly improving, moving away from professional services (which are essentially done at cost) and into subscription revenues, which produced a sky-high 85% GAAP gross margin in the most recent quarter:

Figure 2. Cloudera revenue mix shiftCloudera: Plenty Of Upside As The Company Turns A New Page - Cloudera, Inc. (NYSE:CLDR)Source: Cloudera Q4 press release

As seen above, Cloudera’s revenue mix shifted four points into subscription during FY19, which also helped it to drive a huge GAAP gross margin improvement to 72%, up from 58% in FY18. The bottom line here: though Cloudera is facing natural deceleration as it nears a billion-dollar run rate, its business is built atop a powerful recurring revenue foundation with rich margins.

Bargain valuation

Last but certainly not least, Cloudera now has one of the cheapest valuations across the entire SaaS sector. The company now trades at a market cap of $3.11 billion and has $540 million of cash and cash equivalents on its balance sheet, plus zero debt – this translates to an enterprise value of $2.57 billion.

If we take the midpoint of Cloudera’s conservative guidance range of $835-$845 million for FY20, we arrive at a valuation of 3.0x EV/FY20 revenues (and if Cloudera overachieves its initial guidance range by $40 million like it did in FY19, that multiple slides down to 2.9x forward revenues).

This is an untenable valuation for a company with ~20% organic recurring revenue growth. While it’s true that Cloudera’s deceleration no longer makes it as exciting as a fresh SaaS IPO with 40-50% y/y growth, its huge valuation discount makes it worth investing in. Now compare Cloudera’s valuation against other software companies with a growth rate in the ~20% range:

Chart
Data by YCharts

My year-end price target on the stock is $16, representing 4.5x EV/FY20 revenues and 39% upside to current levels. Note that this conservative multiple would still position Cloudera at half a turn below its closest-valued comp, Dropbox.

Key takeaways

The risks to Cloudera are obvious – the company is in the midst of integrating a transformational merger, and the end impact to customers and billings are not yet clear. However, with Cloudera trading at just 3x forward revenues, I’d argue that much of the risk is already priced into Cloudera’s stock. Irrational pessimism has taken hold over the stock since it issued FY20 guidance – especially when we consider the fact that majority of the guidance miss was due to accounting shifts. Stay long here.

Disclosure: I am/we are long CLDR. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.