Informatica Inc.: Growth Should Accelerate From Here (NYSE:INFA)

Overview

My recommendation for Informatica Inc. (NYSE:INFA) is a buy rating, as I expect growth to accelerate from here given that cloud revenue, which is growing a lot faster, will become a larger piece of the business moving forward. The increase in revenue scale and penetration of large customers should also drive margin expansion. Note that I previously gave a buy rating for INFA, recommending a small stake, as 2Q23 results were great with an improved profit outlook. My thought was that as INFA shows further strength in the cloud, that is when one should size up.

Recent results & updates

While I did not give another update after the 3Q23 results (I was swarmed with other companies), I thought it was right to give some thoughts on the share price performance so far. At my last update, the stock was trading at $20, and I had a target price of $28. Today, the stock is trading at $32, which is a 60% gain. Below are my thoughts on how investors should position their stake.

Starting with the results, INFA ended the year with splendid performance, growing 4Q23 revenue by 12% to $445 million, beating the consensus estimate by 400bps. The headline revenue growth does not do justice to INFA, as subscription revenue grew 26% to $300 million, but was offset by weak maintenance and pro services, which were down 9% to $143 million. INFA’s adj. EBIT margin also beat expectations, coming in at 36% vs. 33% (consensus expectation). As a result, adj EPS beat consensus expectations as well, where INFA reported $0.32 vs. expectations for $0.30.

My focus has always been on INFA cloud performance, and the recent results suggest that underlying demand remains strong. A better metric to assess cloud demand is by looking at annual recurring revenue [ARR] performance, as it indicates the “run-rate” performance. In 4Q23, cloud ARR grew 37% y/y, beating management’s own guidance, and remarkably, the growth was driven mostly by net-new ARR growth (23%). Some might nitpick that the 23% net-new growth was a deceleration, but do note that last year was a tough comparison, which saw 48% net-new ARR growth. On an absolute basis, 4Q23 still added >$30 million of net-new ARR, which maintains above the $30 million threshold. This performance also shows that INFA is doing a great job transitioning customers from legacy to cloud. As of FY23, 25% of new cloud bookings came from migrations, up from 15% as of LTM3Q23. I believe the transition phase has reached an inflection point where I expect INFA to start showing stronger results from the go-to-market reorganization and end-of-service of self-managed.

As this happens, cloud ARR and revenue will become a larger piece of the business, and the negative drag from perpetual and maintenance revenue will get smaller. From a percentage growth perspective, INFA total revenue should accelerate as subscription revenue is growing much faster (26% as of 4Q23). Clearly, execution is not a problem based on the results so far; hence, I believe INFA is on good track to continue capturing share in this large address market ($62 billion).

Importantly, INFA could see growth accelerate at a faster pace as it continues to penetrate the G2K customer base, which INFA currently has 45% of (Dec. 23 Investor Day). Given the strong strategic partnership relationships that INFA has made over the years, I don’t see go-to-market as a hurdle here. Landing large strategic customers is way better than acquiring small customers as the project scale is typically larger (data transformation does not only happen at 1 single department), and it also opens up future growth opportunities as INFA could cross-sell other products in the future since it has established a strong vendor/client relationship already (we can see this from the net-new ARR performance). Furthermore, as the amount and diversity of data and sources continue to grow exponentially, INFA’s IPU consumption model should generate opportunities for long-term expansion. Consequently, the potential for increased data usage increases as the customer base grows larger. To put things into perspective, INFA processed 86 trillion transactions in December 2023, which was up 62% vs. last year.

That platform IDMC processed 86 trillion mission-critical cloud transactions in December, growing a whopping 62% year-over-year. From: 4Q23 earnings call

Overall, I think INFA offers investors an asset that is expected to see growth accelerate, backed by strong secular tailwinds, and is going to churn out more free cash flow as the business becomes more profitable. INFA has already proven to the market that it can improve margin; adj. net margin improved by 200bps sequentially and 500bps annually to 22%, which is an all-time high. INFA also generated ~$250 million of FCF in FY23, translating to an FCF margin of 16% and a yield of ~2.5%. As INFA scales, margins should continue to improve.

Valuation and risk

According to my model, INFA is valued at $36 in FY24, representing a 11% increase (1-year gain). This target price is based on my accelerating growth forecast from 6% in FY23 to 8% in FY24 (high end of guidance) and 10% in FY25. As cloud revenue becomes a larger piece of the business, consolidated growth should gradually mirror the cloud’s growth. I also see the same pace of margin expansion moving forward, ~100 bps a year, as INFA grows its revenue base and sees operating leverage. I believe INFA current stock sentiment is very positive, as the INFA has shown clear evidence that growth could accelerate with improving margins, which means earnings growth in the near term is going to be elevated relative to recent history. This should support the current 30x forward earnings multiple, which is at a premium to INFA’s historical average.

The risk here is that INFA is trading at an average multiple, which means there is a lot of room for multiples to see a de-rating. This could happen if INFA shows even a quarter of a growth slowdown, which will significantly impact expectations. Investors might think that the underlying cloud demand is not as strong as it seems to be.

Summary

I maintain a positive outlook on INFA with a buy rating. The company’s strong performance in 4Q23, particularly in cloud demonstrates sustained demand and successful customer transition to the cloud. My expectation is that the transition phase from legacy to cloud has reached an inflection point, which should lead to growth acceleration ahead. As INFA scales, margins should improve accordingly due to operating leverage. While the stock is currently trading at a premium multiple, the positive momentum in earnings growth supports this valuation.