Hortonworks Fourth Quarter Update – The hadoop adoption cycle continues

Hortonworks is the second of the three companies I own that reported on Thursday night.  The first, Ichor Holdings, I wrote about yesterday.   The third, Radisys, I’ll get to shortly.

I originally wrote about Hortonworks along with another company Attunity in November after doing some research on Hadoop and concluding that its adoption presented a good growth opportunity for the companies involved.  At the time the stock was trading at $6, had recently been issued a sell recommendation from Goldman Sachs, and was pretty hated all around.

Nevertheless the company was growing like a weed (40% annually).  It was also bleeding cash flow like a sieve.  But at an enterprise value of less than 2x revenue I found it difficult to pass up the growth.  Knowing Wall Street loves those growth stories, I figured a couple solid quarters would put the stock quickly back on its feet.

Fast forward a few months and that is exactly what you got.  The company is still growing like a weed (revenue was up 39% in the fourth quarter, guidance was for 28% year-over-year growth in 2017), they are not bleeding cash flow quite so materially (cash flow in the fourth quarter was actually close to flat), and the stock isn’t hated quite so much.

At $11 and with a $1.40 of cash the stock is still trading at 2.4x revenue.  So the valuation is actually not that different than when I bought it.  One key difference is that back then the cash level was higher (roughly $130 million), the shares outstanding were lower (the company issues stock like toilet paper) and the price per share was lower, so cash was a much bigger piece of the overall valuation and that was partly what I found interesting.

The most interesting thing about the fourth quarter was that growth in their Hortonworks Data Flow platform has really taken off.  I wrote about HDF in my original write-up.  I’ll repeat how the company described HDF at the Pacific Crest conference last year:

Now [customers] want to have the ability to manage their data through the entire life cycle.  From the point of origination, while its in motion, until it comes to rest and they want to be able to drive that entire life cycle.  It fundamentally changes how they architect their data strategy going forward and the kind of applications and engagements they can have with their customers.   As they’ve realized this in the last year its changed everything about their thinking about how they are driving their data architecture going forward starting with bringing the data under management for data in motion, landing it for data at rest and consolidating all the other transactional data.  So it’s a very big mind shift that’s happening.

I still think HDF could be a big growth driver for the company and we are starting to see that.  They said on the fourth quarter conference call that HDF grew 6x year over year in the fourth quarter.

So there is lots of reason to think growth will continue.  Nevertheless, I am reluctant to add.  It’s the cash flow that still gives me pause.   While the fourth quarter number was good, they’ve approached break even cash flow in the past only to diverge again into big losses the following quarter.   They said on the call that they expect mid-teens negative operating cash flow in the first quarter.

More optimistically, they also said that they expect break-even cash flow in the third or fourth quarter.  So that would be a turning point.  But then in response to a question about whether we should expect free cash flow after that, if felt like they were trying to scale back expectations:

Yes, I don’t want to talk beyond that yet, Q3, Q4 seems a long way out, but from a – if you think about free cash flow we have been running may be $2 million to $3 million a quarter on CapEx. Q4 was a little light, I think it was under $2 million, but I think once we get to the sort of breakeven number sometime between Q3 and Q4 we will reassess to how much above that we want to punch.

So I’m not sure what to think.

Hortonworks also issues a lot of stock, which while it doesn’t factor into the cash flow number, does dilute shareholder value.  The shares outstanding have gone up by almost 3 million in the last couple of quarters.

On the other hand is my experience with Apigee.  Another high growth company, with cash flow, that was issuing lots of shares, and the company never really sorted any of that out yet the stock tripled from the $6 price I bought it at to the almost $18 where it was bought out by Google.  Hortonworks could easily follow that path.

There are certainly reasons to add.  Strong growth, ramping of HDF.  They announced another new product launch, enterprise data warehouse in February, and are gaining traction on their Azure and AWS offerings.  They also stand to gain visually from accounting changes enacting in 2018 that will allow them to defer less revenue and spread out commission expense, in turn improving the income statement.

Nevertheless my gut, informed by the aforementioned concerns about cash generation and stock issuance, is telling me not right now.

I think if the stock pulled back on a market pullback I would be more likely to add.  But it’s hard for me to double up at this price, as I have been prone to do with other ideas that start to work.

So I’ll probably sit with my 2-3% position and watch what the stock does.  I prefer to take the safe route when my gut is giving me pause.