Phiromya Intawongpan
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I suggest a Buy rating for Clearwater Analytics Holdings (NYSE:CWAN). In comparison to its peers, it has surpassed them in terms of margins, with its growth outlook aligning well. I anticipate its current share price will rise in reflection of its enhanced performance over the forthcoming quarters. The advancements in Artificial Intelligence, introduction of new products, and continued efforts to enhance its existing solutions are anticipated to be key drivers for its future growth and net revenue retention (NRR) due to the additional value and features provided to end users.
Business
CWAN operates as a software company, developing cloud-based Software as a Service (SaaS) solutions in-house that cater to businesses in the areas of investment accounting and reporting, compliance, and risk analysis. Since 2020, CWAN’s revenue has demonstrated strong growth of over 20%. It is projected to continue this strong growth with expected increases of 21% in 2023 and 22% in 2024. Over the last 3 years, the gross margin has consistently remained at 72%. The net income has also exhibited robust growth. In 2020, its net margin was at a negative 21.76%, but this has since recovered to a negative 2.63% in 2022. For a better indication of its profitability, it is prudent to consider the adjusted EBITDA margin, which has consistently remained at a healthy level of around 26% since 2020. Overall, CWAN’s revenue growth has been strong, with consistent gross and adjusted EBITDA margins.
Recent results and updates
In Q3 2023, CWAN reported revenue of $94.7 million, marking a 23.7% year-over-year increase. The reported gross profit was $67.7 million, equivalent to about 71% of revenues. The adjusted EBITDA was $28.6 million, representing 30.2% of revenue. This demonstrates a significant improvement compared to the adjusted EBITDA margin of approximately 25% in the same quarter of the previous year.
CWAN reported a robust NRR of 108% in Q3 2023, slightly down from the 109% reported in the previous quarter. However, this represents an increase from the reported NRR of 103% in Q3 2022. This advancement in NRR is attributed to two strategies: the effective deployment of a novel pricing model countering the volatility associated with assets under management (AUM), and the introduction of a flexible pricing system allowing additional fees for the use of extra functionalities by customers. Although not expected to reach its ambitious NRR target of 115% until 2024, the management has expressed strong commitment to achieving this milestone in the next few years.
The substantial revenue and NRR growth can be attributed to CWAN’s dominance in the market. CWAN’s expertise in handling options, global reporting, and regulatory compliance in local Generally Accepted Accounting Principles (GAAP) has positioned it as a top investment accounting solutions firm. This strong reputation fosters the adoption of CWAN’s platform, providing it with upsell opportunities and reinforcing its market position in the region. As a leader in its operating markets, it strengthens my belief that CWAN will sustain its robust growth in the future.
In the competitive cloud-based SaaS solutions market, constant innovation and product improvement are crucial for companies to stay in the lead and capture market share. As of now, CWAN has ventured into Artificial Intelligence. CWAN’s in-house Zen AI solution expedites data consolidation and generates actionable insights. This additional value benefits users, and hence, the entry into the General AI space with Clearwater-GPT likely contributed to the observed growth in this quarter as users gain more benefits and features from the existing products. I anticipate that General AI will continue to gain traction in subsequent quarters, further contributing to revenue growth and NRR, attracting and retaining users.
Aside from General AI, CWAN recently unveiled new product launches and enhancements at its CWAN Connect conference, reflecting its dedication to product innovation, critical for long-term growth. The CWAN platform has been enhanced and now includes advanced self-service capabilities, ESG data and reporting, and income forecasting for non-fixed income assets. These enhancements expand the platform’s capabilities, adding more value to the end-user, which will likely boost the NRR as users derive more value from the products. Furthermore, CWAN introduced a new product, Clearwater MLX, designed to monitor the entire mortgage loan lifecycle. Additionally, it incorporated two new features into Clearwater Prism, including improved European Union support and a web-based editor. These innovations demonstrate its expansion efforts and commitment to providing superior solutions to its users. I anticipate that CWAN’s continual technological innovation and product enhancements will help it maintain its competitive advantage and reinforce its robust market position, as evidenced by its NRR and revenue growth in the quarter. In the long run, I anticipate these initiatives will further elevate NRR, supporting the management’s NRR target of 115%.
Valuation and risk
According to my model, my target price for CWAN in FY24 is $26.60, representing a potential 26% upside. This target price is based on my growth forecast of 21% and 22% over the next two years, supported by CWAN’s full-year 2023 revenue guidance of $367.6 million and adjusted EBITDA of $104 million, representing a margin of 29%. It is evident that in the third quarter, revenues exhibited robust growth at a high double-digit rate. In addition, its adjusted EBITDA margin also increased by nearly 5% year-on-year. With its foray into AI and the introduction of new products and enhancements, I expect these initiatives to drive NRR even higher, making the management’s target of 115% NRR appear highly achievable.
Author’s Evaluation Model
Presently, CWAN’s Forward EV/EBITDA stands at 36.38x, aligning with its peers’ average of 35.69x. A comparison of the EBITDA margins highlights CWAN’s outperformance, with its margins at 5.49% while its peers exhibit negative 8%. This observation also holds true for the net margin, with CWAN reporting a negative 2.63% while peers report a negative 13.69%. It’s important to note that current result comparisons are made for margins while multiple comparisons are forward-looking metrics (based on consensus). This explains why some competitors’ margins are currently negative but their valuation multiples are positive. The consensus may be indicating that margins could explain their expectations; however, CWAN outperforms today and is among the few with positive EBITDA margins.
The expected 1-year growth rates are in line at ~22%. Considering CWAN’s improved margins, I believe it deserves to trade at a higher forward EV/EBITDA. Even with its current multiple, there is still a 26% upside potential.
Bloomberg
There are two risks I would like to address. Firstly, industry consolidation, even for older service providers lacking the cutting-edge cloud-native technology, can increase customer stickiness, posing a risk for CWAN. When larger players acquire smaller firms, end users tend to favor larger companies due to their stability and reliability, which is critical for business software given its vital role in business operations.
Secondly, revaluation may lead to churn due to budget constraints, compelling users to explore other options. CWAN has initiated a new pricing strategy for existing and potential customers, which may trigger a negative reaction from some customers.
Summary
Given its robust third quarter and historical performance, I anticipate CWAN to maintain its current strength in the upcoming quarters and into 2024, leveraging its strong market leadership. The investments in AI and continued product launches and enhancements are expected to support its long-term growth and NRR objectives. Moreover, I expect its multiples to improve, considering its superior margins compared to peers. Taking these factors into account, I recommend a Buy rating for CWAN.
Source: seekingalpha.com
