Clearwater Analytics Holdings, Inc. (CWAN) Earnings Call Transcript & Summary

All right. Thank you, everybody, for joining us. Very pleased to have Clearwater Analytics CEO, Sandeep Sahai, here with us. And thank you again, everyone, for joining. Before we get started, I just have a quick disclosure to read. For important disclosures, please see the Morgan Stanley research disclosure website at www.morganstanley.com/researchdisclosures. The taking of photographs and use of recording devices is also not allowed. If you have any questions, please reach out to your Morgan Stanley sales representative. So Sandeep, with that out of the way, thanks again for being here. We're obviously going to cover a lot of topics across the acquisitions that you've done, NRR, competition, et cetera.

But before we do that, maybe for those that are not as familiar with your business, just give us the high-level story on Clearwater, the arc over the last several years as you've come public and how the business has evolved?

Okay. I could go on with that for 35 minutes [indiscernible] all be done. But most seriously. Basically, what Clearwater does is it does investment accounting. And what that really means is if you're an asset owner, so an insurance company or somebody like that, people trade on your behalf and they report back to you at the end of the day. So we sit in the middle. We'll actually get all of these reports from your managers and then we'll go to your custodians to also check what you have. And then we'll go to your market sources to also figure out what the price is. And we'll take all of those feeds, consolidate it and give you a comprehensive view of your platform across asset classes across the world on a daily basis. And that's what the core platform does. As you invest more and more into alternative assets and other asset classes, that's where it becomes more and more important. It's how do you get a comprehensive view. Why do you need a comprehensive view? Very simple, for investment decisions, that's number one. Risk management, compliance, regulatory reporting, accounting, taxation, all of them demand a comprehensive view of your global portfolio, and that's what Clearwater does. Just in terms of financial profile in the last 5 years, we have grown about 20%, between 20% and 25% each year organically. And we've had small acquisitions, but if you strip that out, you will see that the growth was about 20%, 21% in that region. So we've grown consistently each of those years. Our gross margin used to be 75% in 2022. In the last quarter, it was 78.9%. So we've been able to grow that pretty dramatically. Our EBITDA used to be 26%, and we've been able to grow that pretty dramatically. In the last quarter, it was 35.5%. EBITDA converts to cash quite nicely at 70% rate. And so it's a really solid business. But the foundation of it is this 98% gross revenue retention. So once a client's on our platform, we have a 98% revenue retention rate. And you could go back '24 quarters, and you will see it's the same number with the exception of 3 or 4 quarters. One quarter, it was 97%, 2, 3 quarters, it was 99%. So it's a good solid business because it is mission-critical. People can't wake up and say I don't want to do accounting anymore. We can't wake up and say, I don't want to do regulatory reporting. I mean that's not quite how it works. So it's a nice business. I've been CEO for 7, 8 years. So it's not like I founded the business. But yes, it's -- I have had the privilege of leading it for 7, 8 years now.

Awesome. Maybe just on the core Clearwater stand-alone piece of the business. I think, again, at the time at which you came public, everyone was focused on whether or not you could grow 20% consistently. We're now having the same debate 5 years later. So maybe just on that piece specifically, just walk us through like the various tranches of the business within asset management and insurance and how, in particular, you're feeling about Clearwater's net new momentum in both of those verticals specifically and sort of pairing that with your ability to continue to achieve 115% NRR?

Yes. I've got to admit I was a little surprised by the reaction. I think when we went public, people said, can you grow. And we also said we will grow, but we will improve gross margin 50 bps a year. That's the number we had, and we publicly stated that. And we also said we will grow EBITDA at 200 bps a year, and we publicly stated that also. And it's our history, so you can go back and look. And then the last year, our gross margin improved 170 bps instead of 50. Our EBITDA grew 340 bps instead of 200. So I thought we would have earned a little credit that if we say something it gets done, and we have done it not 1 year and 2 years and 3 years, but 5 years. But yes, so when I look at these acquisitions, I was telling some people earlier, it was a fun story about Tiger Woods. You're #1 in the world. And when he was doing really well, he completely changed his swing. And the point was he felt he was strong enough then to make the switch and still be #1, but getting the thing to endure. I think Clearwater is at a very strong -- the core Clearwater is at a very strong execution momentum right now. And so now is the time for us to try and reach out to other portions of our clients' business. And so that's why you see us pushing today. And I -- a little surprised to see the same questions emerge again. And that's fine. I think we will deliver, and that's all we can do is execute to the plan we have laid out to the market and execute on it. I think we laid out to the market 3 things that we will find in the first year, $20 million of synergy. That was number one. We said we will find 400 bps of gross margin improvement in year 1 and another 400 in year 2. And we said we'll get growth back from 13% to 20% in 2 years. I think we've already found the $20 million, and we have acted upon the $20 million already. Now you won't see it in Q2 because we have onetime costs related to. But I think by the time we see Q3 and Q4, you'll see the entire $20 million flow through super high confidence in getting margins of 400 and 400 probably a lot sooner than we thought. So then the question is about growth. Can we get 13% over 2 years and get back to 20% while continue to grow ourselves at that pace. So look, I think it's a good story. I think it's something clients want. They want this modern technology for investment management.

Super helpful. Maybe just on those acquisitions. Before we sort of dig into the rationale for each of them, it'd be helpful, I think, if you just level set in terms of what the platform looks like today, obviously, being a single instance platform for the majority of the company's history. You've done a lot of internal R&D work to sort of introduce more modules to the market over time, but now there's even more product to sell. So just level set with us on what the platform looks like today and what the road map is for getting the platform to sort of look and feel like one platform, call it, 6 to 12 months out?

Yes. We can just chat about this for a little bit. So firstly, we have a platform which does investment accounting. So let's talk about that. It never stops being developed though. And why is that? Because there are so many new asset classes which get generated by the industry. Do you want a regulation that change is pretty dramatic. The amount of compliance that change is pretty dramatic. So our need to continue to invest is pretty strong when you think about the platform. But everything I spoke about until now has been after the trade. And that's what was Clearwater's strength. What we did not do was what happened before the trade. And that is where Enfusion is way, very, very powerful as a platform, right? The other thing is that the investment in alternatives is growing literally day by day. And what stands out about alternatives is that it is massively opaque. It's very hard to figure out the constituent elements of a CLO or MBS or private credit or private debt. There's just so many tranches after tranches of it. And so to understand risk effectively you need something like a Beacon to go out and model derivatives, to go out and model all these private assets. And so that is what I think it looks like 6 and 12 months from now is you have one platform which starts with order management and execution to investment accounting and regulatory reporting and compliance and in near real-time risk. And that is necessitated, I think, by this movement towards global portfolios and this movement towards alternative assets. And that's nothing we control. It's what the industry controls, people like ourselves. But it is just a bigger and bigger portion of our platform today.

Got it. Maybe just on your goal of creating a single data layer across the front, middle and the back office. Just talk us through like some of the actual technical challenges associated with that. We tuned into the webinar a couple of weeks ago just in terms of your views on the integrated platform. I know there's obviously work being done to accelerate that momentum. But talk us through those guideposts and how you're thinking about time line associated with it?

Yes. So look, I'll just try to explain the problem a little bit because I think the jargon doesn't sort of help too much when you say a single security master. I think -- think about a municipal bond, just something simple like a municipal bond. Traders care about just 5 fields about it. They don't know the price. They want to know some terms and conditions, blah, blah, blah. There's 5, 10 things, that's all they need. So the build platforms and systems, we define the municipal bond at those 10 fields. And then it comes to the middle office for accounting, which cares about tax lot, when it got sold, first in, first out, many other things, the middle office wants to know. And then the risk people want to know 15 other things, is a repayment allowed, what happens if it gets cut by the municipal bond. And everybody redefines what these people will define. So the same security is defined with just 10 fields here, and these people in the middle will have some of the 20 fields and these people have 50 other fields. And that's why it gets complicated because for the same asset class, same security, there are 3 different systems, which have to be reconciled. Now that is the simplest example. Now when you take it across asset classes, everybody's got their own systems for each of these items. And then you take it across countries, and you can see how it becomes a ridiculous mass very quickly. What Clearwater tries to do is we have a single security master for investment accounting. All our clients, all, use the same security master. So if there's a change because of anyone, it triples to everybody. Nobody else does that. We did it because that's how it was set up, so the data plane. We manage all the data for our clients. If you bought software from somebody and installed the software in the cloud, you are responsible for bringing in data from Bloomberg and Refinitiv and everybody else, reconciling it, making it correct, it's your problem. In Clearwater's model, we do that. And that's why it has this massive network effect, which is why you get the gross margin improvement from 70% to 78.9% because of that reason. So I do think it's technologically challenging because we have our own security master and Enfusion has its own. But every other system if they've got 600 clients, there's 600 security masters. In our situation, there's one. So the technological challenge is how do you merge all these security masters, the two of these into one. So it's not short term, but do we think we'll have a version of it out in '26? Yes. Do we think we have a full flowing system in '27? Absolutely. But our game isn't about you have to get to that final situation today. Can we cross-sell effectively? That can start now. And can we start to work more effectively with between Beacon and Bistro that can start now. So I do think we have to get to this holy grail in 12 months even if it was possible.

Got it. Maybe just on the Enfusion acquisition itself. I think one of the areas that I've been particularly focused on is just the capacity of that platform to scale, right? Just the nature of their customer base historically skewing, call it, small and midsized hedge funds, have had a concerted effort over the last couple of years to move into the asset management category. But just the allocation requirements associated with some of your larger customers relative to what the Enfusion platform historically had to handle. How do you think about the time associated to scale the Enfusion platform such that it could be in a position to be adopted by some of your largest customers?

Yes. There is a lot of things I think Enfusion can teach the core Clearwater team and the other way around. Clearwater has $8.8 trillion of assets on our platform, and we process it every day. So we think we can bring the knowledge of scaling systems in [ droves ] to that platform. That team has already been moved. We have the leader who drove much of this for Clearwater. He's working on the Enfusion platform right now. So we think we can bring that capability to them right off the bat. I also want to say that we do know how to work with Morgan Stanley and JPMorgan and Goldman Sachs and Blackstone. And we know how to work with very large sophisticated clients, and we can bring that expertise to them very quickly. And so we feel that Together, we have a much better shot at addressing the entire asset management industry instead of them doing it by themselves or us doing about ourselves because there is something to be said about the front office systems they've built. And if you can ask customers of theirs, I think they are across the board, really happy about it. So that's the strength of Enfusion. As the platform is used by 900 clients, super high satisfaction ratings and -- so we feel it is something you can work off from, if you want.

Maybe on the topic of pricing. You've obviously been successful at Clearwater to sort of transition from a pure AUM model towards, call it, a fixed plus variable component on the AUM side. I know there's debate internally just in terms of how you think about pricing that Enfusion solution just with some of the head count dynamics within the hedge fund space broadly. How do you think about those conversations with customers just given the fact that historically, the majority of those, call it, CIOs or CTOs within the hedge fund space are accustomed to a seat-based model. So how do you think about just the strategy from a go-to-market perspective to execute on some of those potential changes?

Yes. I'm sure all of you use 20 pieces of software. I don't think there's one software where you don't have a 3%, 4%, 5%, 6% increase in price on a yearly basis. It's just not -- it's not how the word it is. Three years back, Clearwater was exactly in that spot. We had zero commercial model changes. There was no price increase. But we did it systematically, and we did it with a big eye towards our customers seeing more value from our platform on a daily basis. So I think it's simplistic to think about, I'm just going to increase the price. It's not sustainable, I think. So I do think it's a bit of a mechanism. And in 2021, when we talked to you, we said, look, it's going to take us 2 years to get this price increase fully in our system. In the first year, it was 1% then 2% and settled at 3.5%, 4%. We don't want 5%. I think 6% and 7% price increase every year is unsustainable because it does compound. And so we think this 4%, 3%, those are things you would pay if someone came to you and said, "I'm going to increase your rent 3% or 4%. I think you would take it. Would you increase 7%, 8%, I don't think people take it. But I do think it's a longer-term thing about how they sell, how do clients derive value, but I do want to say, if you're a client and I do seat pricing, what am I incenting you to do? Have less and less people use my platform. So it's a little bit counterintuitive. I want more and more people to use the platform while watching what value they get for the dollar. So I do think last time we ran a 4-month process with an external vendor about how to change the commercial model, but not focus on price. Price is one component. The other one is the value. Are we investing more in R&D, which brings more performance or more functionality. So I think it's a whole piece. And that's why we have not said that we will do this in 6 months. We said we're going to take 2 years to bring growth back from 13% to 20%. But it will be stable growth. It's not like 21% a year, 16% in the next year, we want it to be consistent growth.

Okay. before we transition to some of the drivers of getting back to 20%, maybe just on that pricing point, in particular, I think one of the dynamics we've picked up just in conversations with customers in this space is generally if you look at some of the ACV dynamics of some of the incumbents, right, they're paying a pretty penny for some of the software. Enfusion generally tends to be a lower ACV price point. So how do you think about your ability to have some level of pricing leverage in these conversations where you're now going to market with a much more robust and front-to-back platform?

Yes, my personal view is that our platform is pretty disruptive, the Clearwater platform. I think Enfusion is also very disruptive. But I do believe that where the industry is going, does need more R&D. I think Enfusion spends about 13% of revenue in R&D. I've always felt that it should be much closer to 20% even in the long-term model. And so I feel like you've got to go back to the product and the platform and the functionality and the value and the money will come. But you can't approach it the other way. I think it's a little bit of a fallacy to believe that I just want to increase price. And I think you go back to value to client. And simply put, that comes from either the platform or for client servicing and what you do. And so we are going to sort of try and change this holistically, which is why we said that margin will improve by only 400 bps in year 1. It's not only quite a big number, but just 400 bps in year 1 and another 400 in year 2. So I tend to view this holistically rather than get superbly focused on price. I don't think it's the right strategy. Our client, by the way, we made this change. It was a dramatic change. We rewrote hundreds and hundreds of contracts and client satisfaction has not changed because we did it methodically. We did it with a lot of eye towards what do clients want, what value they look for. We changed our R&D model. We changed our client servicing model. So I think when you do it comprehensively and clients see more value and you want 4%, that is very, very, very palatable, and that's what we hope to build.

Got it. on the drivers of getting back to 20%, obviously, working through some of the pricing changes, we might be able to see some uplift there. But just in terms of the bridge of going from 13% to 20%, obviously, there's a lot of internal cross-sell initiatives to really plug that gap. But how do you think about just your general conviction level in getting that Enfusion business to reaccelerate back to that level?

Yes. Look, firstly, if we did not have conviction, we wouldn't have done the deal. There was nothing wrong with our story. And sometimes the Board give us a hard time, but hey, you're growing this 20%, your margin is improving, just shut up and keep doing that. And so if we didn't have conviction. I don't think we would have done the deal. So I'll give you a few things we think about. Number one, Enfusion had -- 3 years back, they used to sell only to hedge funds, not only, but almost entirely. And the growth was superior to Clearwater every year. They took all of that R&D money and they pushed it towards asset management. It takes time. And the asset management didn't grow as quickly. Hedge fund growth stalled and the growth rates now came down. So really, the first thing we're doing is taking the R&D team, which is focused on hedge funds and bringing them back into one thing, hedge funds. An entire sales team focused on hedge funds, a product team focused on just hedge funds, GTM team focused on purely hedge funds. Everyone is not going to be selling everything. So I think just the refocusing on hedge funds, I think, will transform the growth rate very meaningfully because they are the bulk [indiscernible] the bulk of the business was hedge funds. And if you don't innovate there, then you're going to die, not die too strong a term. But you will get the flattening of the curve in terms of growth. So that felt like number one. Number two is on asset management itself, we took all of Clearwater's R&D and GTM, and they have now merged it with their efforts around asset management. And so that should accelerate a whole lot faster going back to your scaling points and things like that. Once you can show that because Clearwater does it, you should be able to scale in asset management much faster. And the third thing is this focus on NRR. Again, this is something we did from 2, 3 years back. What does NRR mean? Well, it means much smarter commercial model, which yields about 3.5%, 4% year-on-year. So that is going to happen. Second thing is setting up an R&D team, which focuses on just current clients. So for example, client reporting. We should be able to sell client reporting to all 900 clients. Why aren't we doing that? Managed services, why aren't we doing that effectively? Risk, why aren't we selling risk to all of these people. So really product, which you can go back to the current clients with is the other source of growth. Then comes cross-sell. So I feel like there are 4 different things you could do all in an effort to drive growth. And we would need 2 of these to work to be able to get back to 20%. And so that's how we think about it. Now luckily, we have a lot of room in our P&L to be able to make all of these investments simultaneously while growing EBITDA 200 bps. I mean last year was too hot. We grew 340 bps. But I think our commitment to the market has always been it's going to be 200 bps improvement year-on-year. And so we feel there's enough room to invest in all of these initiatives while growing EBITDA 200 bps.

On Enfusion margins, obviously, those who sort of peel back the onion and look at GAAP EBIT of that business is actually quite profitable and has the capacity to really drive margins higher even on a stand-alone basis. But you mentioned the visibility and the confidence in generating $20 million of those cost synergies. How do you feel about Enfusion margin expansion targets? You communicated the 400 and 400. But if I just, again, take a step back and look about -- look at what you've communicated to the market in the past and how quickly you've executed on that. Just talk us through some of those puts and takes on Enfusion margin specifically?

Yes. So firstly, it's just going to happen. So there's no question of am I confident, not confident. It will just happen. We will do it. And I think we said we'll take a year to get $20 million in synergy costs. We already have the $20 million. And so -- and the revenue is $201.5 million. So $20 million is not a small amount. It's like 10%, right? So that's been executed and done already. I think it doesn't show up for a few months. There's onetime costs of shutting things down, that's okay. But that $20 million is already done. I think on the 400 and 400 bps, I think we have said 2 years. I'd be quite disappointed if it was 2 years. Do I think it could be a year that would be aggressive? Is it somewhere in the middle? I think so. But it isn't -- I don't think it's a question of are we going to do it? It's going to happen. We have the tooling to automate a lot of the work. A lot of the work they do is manual, and it's just not how you should do it. And so we have built all the software, which is how our margin went from 70% 5 years back to 78.9%. We just going to do the same tooling. And so we just expect it to happen.

Got it. Okay. I've been monopolizing time. Anyone in the audience have any questions for Sandeep? If not, I can keep going. Okay. Great. Maybe just on Beacon. I know that's a platform that if you just look at the number of clients and then the ARR of that business, it's actually pretty chunky just in terms of how those deals tend to look on the risk side. I'd be curious like how you think about pairing some of that Beacon functionality with what you already have with Wilshire. What is that -- what is the pairing of the 2 mean? And what does that sort of [ unlock ] in the client base?

Yes. So if you just think about it simply, what Wilshire does is basically performance and risk for equities and fixed income. But when you get to derivatives and alternative assets like private credit, private debt, CLOs, that is something a Wilshire can't do. So Beacon was built ground up to deal with complicated assets. And as you might know, it was funded by Blackstone and PIMCO and people like that who all trade in these alternative assets, which are high complexity. And so it was built from the ground up to allow 2 things. One is deal with all these complicated assets, but make it a very open system, which allows Blackstone to build its own models, which creates alpha and integrate it into Beacon to do these calculations, right? Now that is unlike every other risk system in the market today, which are basically closed systems. You just do it the feed and will give you the result, but you can't bring your own models to the house to the party here. And just by the nature, Blackstone and PIMCO and people like that were we know better, and so we're going to bring our own models to the party. And so between these 2, you would get a view of all privates and publics. And that is the holy grail is if you want to shock something with 25 bps interest rate movement, you want to shock your whole global portfolio. And you don't want to shock equities differently and go into the system and do every asset class separately. But by bringing these 2 things together under a common leadership, we hope to provide an ability to shock your entire system up and down, GFC, whatever that might be, you'll be able to do that. Now why wasn't it important earlier? Because alternative assets were 5% of people's portfolios. Now it's 25%. super important, super relevant. So that's why we felt that you had to do a Beacon. Yes, that's [ fun ].

It is. On that point, do you think like you obviously have the incremental TAM associated with Enfusion. I guess do the incremental Beacon capabilities actually give you an incremental leg up with things like quant hedge funds just in terms of the capability you can deliver there?

Yes, without question. If you look at their standing with -- by the way, what is Blackstone? It's quants. And you go to the biggest customers, the more the quants, the more -- the bigger the need for something like -- if you don't have quants actually, then the Black Box system works quite well because you don't have the quants to do your own models and bring it to the party. But if you have quants, then by definition, they want to build their own models and they want to bring it to the party, which means you have to have a system which is open and allows it. And so yes, the moment you have quants, almost definitely Beacon would do really, really well in that. But if you don't have quants, Wilshire we will do well and be able to bring that to the party. So we think that this allows us to build a comprehensive platform, but it doesn't mean it's available today. All it means is we have all the intellectual property inside the house under one tent with one leader. And what we hope to build in the next 6, 12 months is that. Even if you think about hedge funds and you think about Enfusion, [indiscernible] global macro or risk-aware investing, those will become very natural to Enfusion when it is not that natural. If somebody is doing multi-asset class reporting near real time, yes, without Beacon, I think it's hard. So I do think Beacon makes Clearwater stronger. I think it makes Enfusion stronger. And I think we bring 2,300 clients to the Beacon platform to cross-sell. And so we do think this is all part of the same value chain, if you will.

Maybe just on some of the pro forma metrics of the business. Again, 115% NRR has been your guidepost for quite some time. Obviously, there's some near-term drag associated with Enfusion, just given the NRR of that business over the last couple of years. But if you sort of pair that with both your optimism on pricing as well as the fact that you now have more product to sell, how do you think about just the mix and the drivers of NRR between price, cross-sell, upsell, some of the AUM dynamics and how they're evolving with the acquisitions?

Yes. I think 2.5, 3 years back, we were at 106%, 107%. We built this plan to 115%, and we have executed really well. And we got to 115% back down with Enfusion. And so we're building out the plan to say, how do you bring them back up in 2 years. So I feel like there's a is a really good playbook we have, which centers around commercial model, new product development, changing the client servicing model, which you have just finished after 2.5 years. And I think we just kind of go back to the same playbook almost entirely. And which is why you hear me so confident about margins and all. We have just been through it. We know. And so it's a question of reimplementing it of those plans. But you do start to feel like we just do it, and now we've got to do it again, hopefully, easier this time with the same leaders. If you look at our team of Jim Cox and Subi Sethi, who is the Chief Operating Officer and Scott Erickson and Souvik and Cindy. We've been together for 5 years. So we know this playbook. We have executed it together before. And so there's pretty high confidence in and security again, but it doesn't mean it's not work. I mean there is a lot of work. And we did start with -- I think we have met about 300 clients live across New York, London and Paris and just across the whole world and really sought their input. And I think everything we have said to you, we presented to them. We presented to them how we bring these companies together, single security master, single data plane, which you were asking about, and it's an open system, which others could be able to use. And I've got to tell you that we are lucky that Morgan Stanley and other analysts sort of see the logic, the industrial logic really, really well. And the clients we have spent a lot of time with over the last month in person, I don't think one client has come to me and said, "Why were you guys doing this? They get the rationale sort of literally right away. And so I think we're quite enthusiastic, but it's a lot of -- you have to get a lot of things right. But if we do, then we have diluted 12%, 13% and had 54% of revenue growth from it. It's not of the same quality because it's not -- we said GRR, NRR and the growth is not the same and the margins are not the same. But I do think over the next 1.5 years, we will get all those margins back up and get the growth back up in 2 years, in which case, for shareholders, including myself, it would have been a fantastic deal, which is what we hope.

We look forward to it. Thanks again for joining us, Sandeep.

Thank you.

Take care.