Exasol - David against Goliath in the Data Space
Exasol (XET: EXL) is a promising German small cap competing against tech giants such as Snowflake, Amazon, Microsoft and Alphabet in the Database Management Systems (DBMS) market. Similar to the biblical saga of David against Goliath, Exasol is a clear underdog but should definitely not be underestimated. Overall, I'm impressed by the company and have added the stock to my watchlist, however I won't consider a position at current levels due to an unattractive R/R.
Thesis summary:
Exasol provides a competitive offering with top speed and an attractive cost-to-performance ratio. The quality of the product is hard to ignore and Exasol's customer base confirms this message. The company is expanding aggressively and can be expected to achieve high growth rates for the foreseeable future.
Data is the new oil. The industry is growing extremely fast and Exasol enjoys several tailwinds that support strong growth rates for many years to come. While the company isn't a market leader, they don't have to be in order to make the stock an appealing investment.
I currently consider valuation too high given the fundamentals and associated risks. Exasol's loss making, intense competition in the industry and management execution are substantial risk factors that in my opinion outweigh the rewards for now.
Some useful definitions before diving in:
In-memory technology: enable large amounts of data to be processed in the main memory (RAM). This allows for faster access and processing times.
Column-based storage and compression: Columnar storage and compression reduces the number of I/O (input/output) operations and amount of data needed for processing in main memory and accelerates analytical performance.
Massive Parallel Processing (MPP): connecting multiple servers, or nodes, to form a single unified system, based on a so called shared-nothing architecture, which means that there is no single point of failure within the server cluster. This architectural approach enables high scalability by simply adding additional nodes to the cluster as and when the volume of stored data or the need for additional performance increases.
Exasol's Business Model
Exasol provides analytical database solutions that enable firms to store, manage, access and analyze data at high speed and scale. Exasol's database solution utilizes columnar storage, in-memory analytics and MPP architecture to provide what they claim to be the fastest analytical database since 2008 (TPC-H Benchmark). The in-memory solution uses an algorithm that only loads the necessary data, keeping the hot data in memory while the cold data resides on the disk. This leads to customers only needing 5%-10% RAM compared to their raw data volumes, while other in-memory solutions sometimes require >100%.
Exasol's product helps firms to become more data driven. Exasol's database can either be added as an extension to an already existing data warehouses or replace the legacy data warehouse altogether. The database includes several use cases, such as business intelligence (BI) reporting, enabling ad-hoc queries, running data science models and AI & machine learning (ML) support. Exasol's database can be installed on-premise, in the cloud or in a hybrid environment. It can furthermore be deployed on the most popular public cloud marketplaces, including AWS, Azure or GCP, while Exasol also offers its own ExaCloud solution. The database supports multiple popular programming languages (R, Python, Luna and Java) and integrates with numerous BI and data tools, such as PowerBI, Tableau and Alteryx.
Through its database editions and the opportunity to add nodes for further scalability, Exasol follows a so-called "land and expand" strategy. Exasol currently provides the following three database editions:
Exasol Community Edition: A free single node edition for commercial and academic use. Max. 200GB of raw data, mainly aimed for minor data analysis needs.
Exasol One: Also a single node solution with max. 1TB of data, including all features and support. Applicable for SMB’s or individual departments within an enterprise (€1999/month).
Exasol Enterprise Cluster: Full enterprise version with unlimited scalability.
With regards to pricing, Exasol's database can be deployed in the following three ways:
Fully managed system: SaaS offering completely hosted and operated by Exasol.
Subscription-based: SaaS but deployed on the customer’s infrastructure.
Perpetual license: pay for set data volumes with upsell opportunities depending on data usage.
Exasol plans to only offer subscription options in the future and is therefore still in the transition from a license model to SaaS only. Recurring revenues as a percentage of revenues increased from 64.2% in H1 2019 to 90.7% in H1 2020. The pricing model scales with the data usage, hence Exasol experiences revenue growth from within its customer base as they increase their data volumes. Revenues are mostly derived from the DACH region (Germany, Austria & Switzerland), followed by the North America, Rest of the World and the United Kingdom. Exasol is expanding its headcount aggressively, going from 149 in 2019 to 223 in 2020 and targeting 300+ by the end of 2021. Number of employees is seeing its strongest growth in the sales and marketing department (70%), partly due to the primary focus being on expansion in other European countries and the US.
Competition from the Tech Giants
As mentioned before, Exasol is a relatively small player in a competitive field with both upcoming unicorns and Tech Giants. Some well-known competitors are:
Microsoft
Amazon (Redshift)
Alphabet (BigQuery)
Snowflake
SAP (Business Warehouse & HANA)
IBM (Db2 & Netezza)
Oracle
Cloudera
Databricks
Teradata
I'm no DBMS expert (although I've experience with SAP's business warehouse which is very unimpressive) so it's hard for me to provide a fair judgement. However, from Exasol's fillings and some independent sources, it appears Exasol's product is of high quality. Firstly, Exasol highlights that their in-memory architecture in combination with MPP forms a key differentiator through which it has managed to capture customers from some larger (more legacy) players, such as SAP, Oracle, IBM and Microsoft. The company also emphasizes its remarkable speed, stating to be the fastest in the industry even beating newer players like Snowflake. Their speed results in less infrastructure requirements and therefore lower total costs of ownership (TCO) for customers. This article comparing Exasol to Oracle explains it better than I can.
This brings me to my second and more reliable point of independent extrernal resources stating Exasol's product quality. As mentioned before, Exasol comes out on top in several of the TPC-H Benchmark tests, an unbiased non-profit organization comparing database processing performance, ranging from 300GB to 100TB in raw data volumes.
Furthermore, a recent survey by Dresner Advisory Services on Analytical Data Infrastructures (ADI) demonstrates how Exasol together with Snowflake are the overall leaders with regards to customer experience and vendor credibility. Exasol also got recognized as a strong performer in Forrester's latest report on Cloud Data Warehouses, where it received the highest score possible with regards to performance. Exasol used to be included in Gartner's Magic Quadrant, but isn't anymore due to changes in entry requirements (>40M$ in annual revenues or >50% growth). However, Exasol's enterprise cluster receives highly positive reviews on Gartner peer insights with many customers praising its performance, flexibility and customer service.
Which brings me to my final point: Exasol's customer base. Exasol has managed to acquire some impressive large customers over the recent years, such as Zalando, Otto, Adidas, CVS, Revolut, Vodafone and Badoo. The fact that these companies went with Exasol is in my opinion a strong indication of the company's product quality. Exasol currently has 195 customers in total, up from 175 in 2019. I expect a lot more customer acquisitions in the future, especially in the US, with the S&M expansions and capital injections. All in all, external reviews and the customer base appear to confirm Exasol's own message of being a strong performer in the DBMS space.
Nevertheless, Exasol faces one major problem from my point of view: its brand. As the popular saying goes: "Nobody gets fired for buying IBM", I think this quote also applies to the DBMS space, where CTOs or CDOs cannot go wrong by simply choosing Redshift, BigQuery or Snowflake. The officer responsible needs to be very confident and convinced to prioritize Exasol over its competitors. Just having a competitive/faster product isn't sufficient enough. Additionally, it is relatively easier to adopt the DBMS services from cloud infrastructure providers/ecosystems, such as GCP, AWS or Azure.
DBMS Industry
Another popular saying is that data is the new oil. Data management and analytics have received a lot of momentum over the recent years as businesses increasingly rely on it to improve their operations. Data stands at the foundation of digital transformation (digital economy) and aids companies with innovating and personalizing their services. Exasol enjoys massive tailwinds from both increasing volumes in data and the shift towards the cloud. An IDC white paper expects the summation of all Global data to increase with 27% annually from 2018-2025. Simultaneously, estimates are that 49% of the world's stored data will reside in the public cloud (up from approximately 30% today) with 90% of the fortune 1000 having a multi-cloud strategy in 2024.
Statista estimated the Global Data Analytics Market to be worth $169B in 2018, of which 25%-30% consisted of DBMS ($42B to $50B). This is not far from Marketwatch's $30B+ for the Data Warehouse space or Gartner's $54B for DBMS in 2019 (+18% YoY). Anyhow, Exasol experiences a fast-growing global trend with a large TAM. AI, ML and BI form core pillars for future growth opportunities. Also, the industry is currently still filled with legacy database architectures that aren't built for today's data requirements. These legacy solutions often lack scalability, have capacity constraints and aren't designed for cloud adoption. Hence, Exasol is well-positioned to continue taking market share from outdated incumbents (e.g. SAP, IBM and Oracle) while competing with other more modern solutions (e.g. Amazon, Databricks, Google, Microsoft and Snowflake).
Management & Ownership
Exasol, which initially started as a university project, was founded in 2000 by Michael Gutzmann and his student Falko Mattasch. They were one of the first to develop in-memory database solutions before it became a more wide-spread concept. After developing the product for years, the duo made significant progress in creating an uncontested leader in the database market. Nevertheless, management was incapable of properly selling the product to the market. Following Mattasch's words in an interview: "[...] we made the typical mistake of a German firm by putting a lot of effort into engineering and not into marketing".
This led to an organizational change with Michael Gutzmann leaving as CEO in 2008 and an increased focused on commercialization. From then on the company improved its sales pipeline and continuously managed to add new customers. However, Exasol has over the years been incapable of raising capital to boost company sales. From what I've been told, this was partly due to co-founder Falko Mattasch being extremely risk-averse. Nevertheless, this has changed with Exasol's IPO in May 2020 during which the co-founder got bought out. The company also raised additional capital through a heavily oversubscribed private placement last December at €19.50 a share. It's clear that the company is steering in a new and more aggressive direction.
Current CEO Aaron Auld has been at Exasol for close to 15 years and been the CEO since July 2013. Auld has prior experience at other technology companies and a master's degree in law from St. Gallen. Mathias Golombek has been the CTO since 2014 and has worked at Exasol for 17 years (!), starting as a software developer and climbing his way up to head of R&D in 2007. It's positive to see that the CTO has such great experience at the company and been involved with the product development. CFO and COO Michael Konrad joined Exasol in 2015 and previously worked as CFO and CEO at Asknet AG.
I currently see two negatives with the management team. Firstly, the management team in my opinion lacks a strong track-record. While they have adequate backgrounds, it does not scream world-class. One certainly needs top-notch management when competing against the best companies in the space, for example Snowflake, led by the very successful CEO Frank Slootman. Exasol is relatively small and has just started its aggressive growth journey, which requires an extremely competent management team in order to successfully execute the new strategy. Secondly, management does not include any founders and the current team has basically no skin in the game. All three officers mentioned earlier have less than 0.1% stake each in the company. Exasol does have high insider ownership though with the supervisory board owning close to 31% of the company. This is mainly derived from Dr. Knud Klingler, who owns a 25% stake and has been member of the board since 2008. The company also holds an additional 2.7% in their treasury.
Financials
Some key financial highlights:
Revenue: 24% CAGR (2015-2019)
Gross Margin: 90%
Positive OCF from 2015-2019
Annual churn: 4.8% (3-year average)
LTV/CAC: 21.3x (17.7x 3-year average)
Net Cash Position
As said before, Exasol has started a new growth trajectory by raising capital and investing heavily in its sales team (+70% from H1 2020 to H2 2020). Revenues only grew 9% in 2020 due to the company switching from a licensing model to subscription services. The company achieved a 37% growth in ARR in 2020 and guides for >45% growth in 2021. It should be noted that Exasol has 9+ months sales cycles, hence the recently made investments won't be fully reflected in the current and 2021 numbers. Exasol has been profitable in the past on an adjusted EBITDA basis (~15% margins), but is not expected to be so for the next few years due to its growth strategy.
Since Exasol has high gross margins, the majority of the company's expenses come from personnel and other operating expenses (incl. travel & marketing). These expenses have ballooned over the last years due to strong increases in headcount and significant one-off items such as IPO costs and share-based payments. Furthermore, looking at the graph below indicating the expenses as % of revenues also provides a slightly false picture due to the earlier mentioned switch in revenue model and lower revenue growth rate for 2020. Nevertheless, expenses are extremely high and Exasol has to scale the business model in the future since these proportions aren't sustainable. I have no doubt about the company's scalability potential, however I do not expect significant movements towards profitability in the upcoming years.
Exasol currently has a solid balance sheet, partially due to its recent IPO where the company raised €48.5 million in cash. The company only had €88.6 thousand of debt in H1 2020, hence a strong net cash position. From the cash flow statement we can furthermore conclude that the company experiences negative changes in working capital (excl. cash), therefore higher cash flow margins.
Valuation
With regards to valuation I take two (very simplified) approaches. The first and more easier way is to just value Exasol based on EV/ARR, forecasting it a couple of years out and then discount it back to today's value using peer multiples as a reference point. The table below provides an overview of software peer valuations in both Germany and international markets. No definitive conclusions can be drawn due to the significant differences in business models, growth rates and margins. However, we can see that Exasol belongs to the group with the fastest growth and highest gross margins. Nevertheless, Exasol is also the most unprofitable and trades at a relative premium compared to its peers.
I use a very quick & dirty approach for my valuation, mainly due to time constraints, laziness and the current opportunity not being intriguing enough to really make a deep dive. For my forecast estimations, I assume Exasol to beat its guidance for 2021 and grow ARR at a 32% CAGR until 2025. Moreover, I expect free cash flows to turn positive in the final year. The figure below shows that using these assumptions one can expect a 9% annual return when exiting at a 10x EV/ARR. Given the risks of the business (loss making, competition and management) I find this way too low. So either my estimates are way off or investors see the business as less risky than I do. Anyhow, an ideal target price for me would be more around €16, or a 38% draw down. While this isn't uncommon for high-growth tech stocks, it might be too low of a target according to the market right now.
The second way of valuing Exasol follows a similar approach, but includes free cash flow estimates looking further out in the future (at least 10 years) and then value it based on an expected free cash flow yield. In this case I use a 21% top line CAGR until 2030 and assume 30% free cash flow margins at maturity. Applying a 10% discount rate and a 5% FCF yield exit multiple provides me with a fair value of €17,90 per share. Looking at both methods and sensitivity tweaks on discount rates and exit multiples, I would argue that the €16 to €20 range looks attractive with current information and my estimates. As always, valuation is an art, not a science, so don't take my target prices as true fair values.
Conclusion
All in all, Exasol is an interesting German small cap with lots of potential. The company enjoys massive tailwinds from growth in the DBMS market and the transition to the cloud. Exasol's customer base and external reviews confirm the high quality of Exasol's services, providing customers with one of (if not) the fastest analytical database out there. The company's growth strategy sounds very exciting with significant expansions in the sales force and stronger focus on the US market. Exasol switched from a licensing model to subscription services, leading to high growth rates in ARR which is expected to continue for the upcoming years. The company furthermore carries high gross margins allowing for strong profitability in the future. Nevertheless, Exasol in my opinion carries substantial risks. Firstly, the company is very unprofitable right now due to its growth strategy. Secondly, the company experiences strong competition from tech giants (Snowflake, Amazon, Google etc.) who have much more resources and talent. Third and lastly, I'm not totally convinced by the management team yet as they don't hold significant stakes in the company and do not possess track-records of comparable quality. Therefore, I do not consider Exasol an attractive investment at current prices. Moreover, I would not consider any purchasing until the price drops in the €16-€20 range.
Disclaimer: I’ve no position in Exasol at the time of writing this blog post. The information contained in this report shall not be understood or construed as financial advice. I am not a financial advisor, nor am I holding myself out to be, and the information contained in this report is not a substitute for financial advice from a professional. I shall not be held liable or responsible for any errors or omissions from this report or for any damage you may suffer as a result of failing to seek competent financial advice from a professional.