Splunk: Future Tech Behemoth Still Trading At Modest Levels
Summary
- Shares of Splunk remain down ~20% year-to-date for no apparent reason.
- The company is just passing the jump of its cloud transition, as revenue has started turning positive again, with cloud bookings exceeding >50% of the total.
- ARR growth is still clinging to a rapid ~40% pace.
- A recent $1 billion convertible stock investment by Silver Lake Partners, with a strike price of $160, signals upward confidence in the stock.
- Splunk is still trading attractively at <8x next year's revenue.
Splunk
Economic Moat Rating increased to Narrow from None
“We are raising our fair value estimate for Splunk to US$154 per share from US$126 while changing our moat rating to narrow from none and maintaining our positive trend rating. We are upgrading our moat rating to reflect our increased confidence in Splunk’s ability to attain sustainable profitability.
In a world where machine data is growing at an exponential rate, Splunk’s platform is empowering companies to generate meaningful, real-time insights from the data in order to maintain critical operations related to security and IT infrastructure. A key advantage of Splunk’s platform is that it can easily index massive amounts of unstructured, machine data using a proprietary "schema on the fly" process. This indexing process quickly identifies fields like user IDs, time stamps, device sources, and error codes, and offers a user-friendly querying tool to generate real-time, actionable insights from the data. Machine data is expected to increase over 40-fold from 2009 to 2020, and the amount of data that Splunk’s platform allows customers to process in real time sets it apart, with its largest customer collecting over 7 petabytes of data per day. We believe that this unique schema-on-the-fly indexing process has allowed Splunk to carve out a moat and provides it the opportunity to increase by revenue double digits for the next decade.
Given the company's technology platform, which can be used to better manage operations at the busiest airports in the world as well as Subway restaurants, we believe no competitor can address the same breadth of use cases as Splunk. We believe that improving customer metrics indicate increasing customer reliance on Splunk due to its flexible deployment options and the growing importance of machine data. Over 80% of new license bookings come from existing customers while the average license order size more than doubled from 2014 to 2018. Splunk is seeing similarly strong trends in large order growth and rising maintenance renewal rates.”
--John Barrett, analyst
More Than Just Security,
Splunk Is a Big Data Play Pivoting to the Cloud
Dan Romanoff
In a highly digitized world, Splunk’s Data-to-Everything platform enables businesses to gather and analyze vast quantities of data (Big Data) generated by complex operations and derive meaningful insights from it. As business needs become more complex and data usage grows, we believe narrow moat Splunk faces a long runway for growth as it pivots toward becoming a cloud-first company.
Splunk’s software primarily addresses use cases in three core areas: security, IT, and observability. Via forwarders, Splunk extracts data from different business sources, indexes the data, and then allows users to query the data using its proprietary schema-on-the-fly offering to generate results in the form of reports, charts, and dashboards. The company utilizes powerful machine learning (ML) capabilities to improve its offerings and address a wide range of customer use cases. Popular deployments include cybersecurity threat detection, ML IT predictive analytics, and application performance monitoring for developers.
Splunk’s moat is supported by strong user metrics, with cloud dollar-based net retention being best-in-class and consistently north of 120%. As of fiscal 2020, over 90% of Fortune 100 companies use Splunk’s platform to monitor and analyze data. The number of customers generating over $1 million in annual recurring revenue also expanded to 510 in fiscal 2021, compared with 124 in fiscal 2018. These figures point to increased adoption of Splunk’s platform. We also consider Splunk as a leader in the IT operations management and security space, as few firms can address a similar breadth of data use cases.
Splunk has been undergoing a cloud transition for some time and recently became cloud-first, with over 50% of bookings coming from its cloud product. Even though we expect near-term top-line and cash flow pressure as term licenses see large upfront payments while cloud sees a recurring revenue stream, the pace of adoption makes us confident that the cloud-first transition will be successful and support healthy future cash flows. We believe Splunk is well positioned for robust growth, supported by strong switching costs and network effects.
We believe Splunk warrants a narrow moat rating as a result of switching costs and network effects associated with its broad suite of products. Splunk’s platform can ingest, index, and analyze vast quantities of data that supports businesses’ ability to maintain and monitor mission-critical functions in a variety of cases within security, IT operations, and observability. We believe that Splunk’s wide array of products that employ machine-learning capabilities to support essential operations benefit from high customer switching costs and network effects, as supported by strong user metrics. In our opinion, this will drive excess returns over the next 10 years.
As businesses have grown and operations have become increasingly disparate and complex, they have run into the issue of aggregating data in a timely and effective manner to help drive insights, flag potential issues, and monitor system/application performance. Splunk’s comprehensive Data-to-Everything platform allows efficient, real-time data collection and enables organizations to monitor this data and derive insights from it.
Via forwarders, Splunk extracts data from different sources within a business (be it security, IT, or DevOps) and indexes the data on the fly, enabling rapid data usage for a wide range of uses. A key distinction of Splunk’s indexing capability is its “schema-on-the-fly” offering, which lets users collect unstructured data (core to Big Data) and then query this data via its easy-to-use interface (identifiable search fields include user IDs, error codes, and so on), allowing for rapid satisfaction of a range of uses. In contrast, “schema-on-the-write” products such as SQL require structured, predefined data inputs, which limit output use cases and reduce flexibility in what can be done with the data.
A key example of how businesses can use Splunk’s platform and benefit from it is the case of Domino’s Pizza. To access a broader range of customers and simplify the pizza order process, Domino’s offers over 15 different ordering channels, from its website to mobile apps to smartwatches. Alongside ease of ordering, customers also expect proper technological performance, as well as personal data security within the Domino’s platform. As a result, the company employs Splunk in a variety of different use cases, including monitoring the health of its applications to ensure a seamless customer experience, watching for security threats, resolving incidents in a timely manner, and analyzing data to support innovation.
Splunk’s moat is primarily a result of customer switching costs, which stem from a variety of sources. Our general view is that enterprise software companies mainly tend to compete with each other on the basis of features and functionality. Splunk offers a suite of products linked to its Data-to-Everything platform that ensures smooth business operations and generates data analytics and insights. Splunk’s products cater to use cases in three primary areas: security, IT, and observability.
Out of its three core areas, we view Splunk as a leader in security and event management and IT. With its acquisition of SignalFx in 2019, we view the company’s footprint expanding in the observability arena as well. Security uses include threat detection (suspicious user activity, for example) as well as incident monitoring; IT cases include cloud infrastructure monitoring and predictive system analytics; and observability uses include monitoring application health for developers, and application modernization to maximize performance and drive innovation.
We contend that Splunk benefits from customer switching costs in several ways. First, we believe that implementation of Splunk’s products can require some time and effort, with time to deployment ranging from a few hours to a few weeks depending on the complexity of needs. Individual users can download Splunk and start using it relatively quickly, but larger organizations have more complex needs and often need to use Splunk’s professional services to deploy its platform. We point to the fact that Splunk’s forwarders have to be integrated with a wide variety of software within a business so it can gather relevant data. Businesses can also incorporate custom applications and add-ons offered by Splunk to suit their specific use case, which makes Splunk more tightly integrated with the business’ operations. Additionally, employees would need some training to ensure that they get the best use out of Splunk’s platform. Given the investment required in implementing the platform, a customer would be less inclined to shift vendors, giving rise to switching costs.
Second, once Splunk’s software is integrated, switching to a new platform could lead to business disruption and operational risk, resulting in data loss. For instance, if a business decides to migrate away from Splunk Enterprise Security (a security solution) to a different vendor, there could be a disruption in security data monitoring, threat incident response, and efficient event management. Given the importance of security, especially in the increasingly digitized world, such a disruption could be dangerous for business operations and lead to a data breach that could impede customer trust in the company. It is also possible that the new system could be integrated incorrectly, missing key threats, or that users would make mistakes while analyzing data in a new format. Alongside productivity costs, there could be direct time and other expenses associated with transitioning to a new vendor, including paying for the installation of new systems and having to spend more internal hours on incorporating functionalities that could provide a similar degree and quality of services that Splunk does.
Third, Splunk’s platform requires initial training and professional services so businesses can derive maximum value out of its products. Training can last up to several weeks, depending on the number of use cases being addressed by Splunk; once training is complete, the platform can be relatively easy to understand, even for non-developers. For instance, the company’s proprietary coding language, SPL, can be used to easily conduct high-speed, intelligent searches within the indexes of data to derive value from it. The initial learning curve and later ease-of-use is a unique combination; businesses would lose the time invested in understanding Splunk’s platform if they migrated to a different vendor and would have to spend a similar amount of time retraining for a new system; the new vendor might not have a similarly efficient user interface. Nontechnical users may have to use expensive developer support to conduct data analysis and derive insights, which would lead to wasted business resources. All these factors lead to increased switching costs for Splunk.
Businesses usually first adopt Splunk’s products for IT use cases, before expanding into other areas. Splunk splits its three core areas, namely security, IT, and observability, into buying centers, and targets cross-selling between these buying centers. With Splunk pursuing a shift to the cloud, it will be easier to leverage this cross-selling opportunity and expand Splunk’s footprint within different businesses. Annual recurring revenue per customer effectively doubles within a year as they expand into new buying centers, increasing by over 6 times in three years.
Splunk has made significant investments in expanding its product suite to target additional use cases. Further, its platform enables businesses to have one holistic view of all the data for their use case in one place, versus having to pursue insights from different sources and build a complete picture themselves. Businesses will benefit from incorporating use cases across buying centers as they will be able to view the interactions between different segments of operations in one place; this will also drive excess returns for Splunk. As Splunk’s products become increasingly integrated in mission-critical business functions, it becomes more difficult for customers to uproot its software and move to a new vendor, enhancing switching costs.
Splunk had over 19,400 customers as of fiscal 2020, up from 15,000 in 2018. In fiscal 2021, 510 customers are generating over $1 million in ARR, compared with 124 in 2018. This is indicative of customers’ inclination to use Splunk’s comprehensive suite of products to monitor, analyze and search machine data. This is also supported by Splunk’s cloud dollar-based net retention rate, or DBNR. Splunk has consistently maintained a DBNR in excess of 120% over the last several quarters; existing customers have been increasing their usage of Splunk’s products. We believe that this DBNR metric is toward the high end of the leading, moaty software companies we cover. This metric is also indicative of the value businesses derive from its platform and is supported by strong average revenue per user growth of approximately 12% over the last five fiscal years.
Splunk recently announced a gradual transition to workload-based pricing from ingestion pricing. Under ingestion pricing, businesses were paying for the amount of data they were inputting into Splunk’s products, while under workload-based pricing, they will be able to import as much data as they desire, and pay for the computing capacity they use to analyze and monitor the data. This will benefit Splunk, as greater amounts of data stored with its platform means that companies are more likely to run analytics for new use cases since all the data necessary to do so is already stored with Splunk. A key example of this is an unnamed Fortune 100 customer which transitioned to workload-based pricing. The company’s average daily data ingest nearly tripled from 28 terabytes to 76 terabytes a day. This also led to an increase in search volume from 20 million to 23 million, with volumes growing from 37 terabytes to 109 terabytes per day. In essence, more data in Splunk led to more users, more searches, and more analytics. This new pricing should thus support switching costs, as higher data ingestion leads to more use cases, making Splunk an increasingly integral part of business operations.
Network effects serve as a secondary moat source for Splunk in two ways. First, the company’s software has strong machine-learning capabilities that constantly iterates on vast quantities of data to become more efficient at anomaly detection, incident response, and data analytics. As more data flows through Splunk software, it can learn to provide more accurate and timely insights for a wide range of use cases, improving the value businesses derive from Splunk’s platform. Pre-existing Splunk users benefit when new customers use its product as the company’s algorithm can become more effective at tackling specific use cases, while new customers benefit from the knowledge Splunk’s software has gathered from pre-existing users to improve efficiency. As of the latest release of Splunk’s system, the company has scaled up machine-learning performance by 400% by incorporating new algorithms to improve efficiency and increasing its value to businesses. As Splunk’s machine-learning offering becomes more efficient, businesses can derive value from their data in a wider range of uses and are likely to move more data into Splunk’s platform; increased usage by current customers combined with new customers wanting to harness Splunk’s machine-learning capabilities will help drive excess returns for the firm.
Second, Splunk allows developers and general business users to integrate apps into core Splunk offerings to help derive greater insight from data. These apps can be obtained from Splunkbase, Splunk’s app store, which offers already-built apps and allows developers to create new ones for additional uses. Developers can make these apps available on Splunkbase to other users, with the platform touting over 2,000 apps as of 2019. An example is Splunk App for Amazon Web Services, which enables the collection and analysis of data from AWS sources to deliver operational and security insights through prebuilt dashboards, alerts, and reports. The app store exhibits network effects as new users would attract new developers to the platform who have greater visibility for their apps, while users would benefit from new developers as they have access to a wider array of apps to augment their data insights. This ability for users to customize their Splunk products and generate personalized analytics and reports is likely to attract new customers for Splunk, which in turn will attract new developers as they can reach a wider audience. As a result, Splunk can sustain its growing user base, supporting excess returns.
Our fair value estimate is $164 per share, implying a 2021 enterprise value/sales multiple of 11 times.
In our base scenario, we expect revenue to grow at a compound annual growth rate of 25% through fiscal 2026. This growth will be a result of increased usage of Splunk’s products by existing customers, as well as an increase in new customers (we expect a 13% CAGR over the next five years). While approximately 25% of Splunk’s revenue currently comes from cloud services, we expect this number to grow in later years as Splunk completes its pivot into becoming a cloud-first company; we expect cloud services to constitute 90% of total revenue by the end of our explicit forecast period. This shift to cloud will propel customer growth as we move into a cloud-driven economy, enable more efficient cross-selling and support additional use cases. As pressure from the cloud transition eases, we believe Splunk can enjoy strong long-run top-line growth; this will be supported by a ramp-up in pandemic-induced business digitization efforts.
Historically, Splunk has reported strong GAAP gross margins, averaging 80% over the last five fiscal years; this is within the 75%-85% range seen for a typical SaaS company. However, the cloud transition will pressure future margins, as Splunk is seeing higher costs associated with cloud infrastructure. Over time, scale and cost mitigation strategies (for example, stateless indexes) will help reduce some of these expenses. We expect Splunk to report an average GAAP gross margin of 75% over the next five years. However, as the firm scales and the cloud transition wraps up, we expect this to approach the low to mid-80s both on a GAAP and non-GAAP basis.
Splunk should benefit from operating leverage, and we expect expansion in non-GAAP operating margins into the high teens by fiscal 2026. While sales and marketing costs averaged 63% of revenue over the last five fiscal years, we expect this to decline to 40% by fiscal 2026, serving as a key driver of scale-based leverage. Over time, we should see this translate to excess returns on the bottom line. Non-GAAP operating margins have been in positive territory since fiscal 2015. While GAAP operating margins are yet to turn positive, we expect increasing scale to enable that possibility in the longer term.
We assign Splunk a high uncertainty rating. First, Splunk is currently undergoing a cloud transition, and has become a cloud-first company, reaching 51% of software bookings as of the latest quarter. This transition is accompanied by lower licensing sales, so the company will face a near-term dip in revenue during the transition. The lack of revenue growth in fiscal 2021 during the transition has been exacerbated by COVID-19.
Second, Splunk operates in a highly competitive space, with large incumbent players such as IBM, Dell, and Cisco also offering similar services to Splunk. These firms have longer operating histories, more resources, and better brand recognition, which deliver them an edge in this arena. If they venture further into real-time data insights, they could impact Splunk’s position as a leader in its core areas. Furthermore, the industry has seen a trend of consolidation, and as large players expand their offerings via inorganic investments, Splunk faces more pressure in maintaining its leadership position.
Third, Splunk has yet to generate GAAP profitability as it maintains a high level of investment in the business. This leads to uncertainty regarding the timing of future profitability, heightened by the firm’s cloud transition.
We see low environmental, social, and governance risk for Splunk. Splunk handles sensitive data, and a breach could raise legal and regulatory hurdles and adversely affect its reputation. In addition, given the complexity associated with software development, Splunk faces competition for scarce skilled labor in the space. If the firm is unable to effectively source and integrate new employees, this could slow innovation and affect its competitive positioning.
We assign Splunk a Standard capital allocation rating. In our opinion, this rating is reflective of a sound balance sheet, sound investments with regard to strategic priorities and execution, and appropriate shareholder distribution policies.
Splunk maintains a healthy balance sheet, with $1.9 billion in cash and short-term investments versus $2.3 billion in convertible debt as of April 2021. A large proportion of debt does not expire until 2023, and we believe the firm does not face material risk in terms of funding it.
Splunk does not pay dividends or engage in buybacks, instead focusing on reinvesting returns to support growth. Stock-based compensation has also constituted a large portion of Splunk’s capital allocation strategy. Over the last five fiscal years, Splunk has spent over $2 billion on stock-based compensation; this is much higher than spending on capital expenditures and acquisitions during the same period. Since 2016, this figure has grown over 80% to $545 million as of fiscal 2020. Even so, it represents approximately 25% of operating expenses, compared with about 35% in fiscal 2016. Meanwhile, capital expenditures have averaged approximately 4% of revenue over the last five fiscal years.
We think Splunk’s management team is making sound investments. Splunk was founded by Michael Baum, Rob Das, and Erik Swan in 2003 in a quest to make sense of the “nonsensical,” particularly in relation to unstructured machine data. Godfrey Sullivan served as CEO till 2015, helping take Splunk public in 2012. Douglas Merritt replaced Sullivan and is the current CEO and president; he touts an impressive professional record, having held previous positions at Cisco and SAP. Since taking control, Merritt has turbocharged Splunk’s cloud transition, reorganized sales and marketing efforts, and revamped the firm’s technological targets. He is supported by CFO Jason Child, an Amazon veteran. Other members of Splunk’s management team exhibit strong software backgrounds as well, coming from the likes of Dell, Yahoo, and SendGrid. Collectively, executive officers and directors own less than 1% of outstanding shares.
In our opinion, Splunk has done a good job in making both organic and inorganic investments to grow its platform. This is reflected in the company’s decision to allocate capital to strategic acquisitions, with the purchase of SignalFx for approximately $1 billion in calendar 2019, and the recently announced acquisitions of Plumbr and Rigor for an undisclosed amount in calendar 2020. Alongside the SignalFx acquisition, Splunk has made several tuck-in 硬塞進去 acquisitions, including the purchase of Omnition for an undisclosed amount in calendar 2019 and the purchase of Phantom for $350 million in calendar 2018. Omnition, in conjunction with SignalFx, supports monitoring and logging of data in apps using more modern architecture (eg. microservices) and is incorporated in Splunk’s Observability Suite; Phantom supports security operations via automation and improved efficiency. While it may still be too early to fully determine the success of its largest acquisition, SignalFx, we believe that these strategic acquisitions have generally been accretive to Splunk’s top line as they add new capabilities to the firm’s product suite and support an expanding range of uses. We expect management to continue to pursue small acquisitions in the future to supplement its investments in organic growth and build out a comprehensive data analysis platform.
Capital Allocation by Nupur Balain Jun 03, 2021
We assign Splunk a Standard capital allocation rating. In our opinion, this rating is reflective of a sound balance sheet, sound investments with regard to strategic priorities and execution, and appropriate shareholder distribution policies.
Splunk maintains a healthy balance sheet, with $1.9 billion in cash and short-term investments versus $2.3 billion in convertible debt as of April 2021. A large proportion of debt does not expire until 2023, and we believe the firm does not face material risk in terms of funding it.
Splunk does not pay dividends or engage in buybacks, instead focusing on reinvesting returns to support growth. Stock-based compensation has also constituted a large portion of Splunk’s capital allocation strategy. Over the last five fiscal years, Splunk has spent over $2 billion on stock-based compensation; this is much higher than spending on capital expenditures and acquisitions during the same period. Since 2016, this figure has grown over 80% to $545 million as of fiscal 2020. Even so, it represents approximately 25% of operating expenses, compared with about 35% in fiscal 2016. Meanwhile, capital expenditures have averaged approximately 4% of revenue over the last five fiscal years.
We think Splunk’s management team is making sound investments. Splunk was founded by Michael Baum, Rob Das, and Erik Swan in 2003 in a quest to make sense of the “nonsensical,” particularly in relation to unstructured machine data. Sullivan served as CEO till 2015, helping take Splunk public in 2012. Douglas Merritt replaced Sullivan and is the current CEO and President; he touts an impressive professional record, having held previous positions at Cisco and SAP. Since taking control, Merritt has turbocharged Splunk’s cloud transition, reorganized sales and marketing efforts, and revamped the firm’s technological targets. He is supported by CFO Jason Child, an Amazon veteran. Other members of Splunk’s management team exhibit strong software backgrounds as well, coming from the likes of Dell, Yahoo, and SendGrid. Collectively, executive officers and directors own less than 1% of outstanding shares.
In our opinion, Splunk has done a good job in making both organic and inorganic investments to grow its platform. This is reflected in the company’s decision to allocate capital to strategic acquisitions, with the purchase of SignalFx for approximately $1 billion in calendar 2019, and the recently announced acquisitions of Plumbr and Rigor for an undisclosed amount in calendar 2020. Alongside the SignalFx acquisition, Splunk has made several tuck-in acquisitions, including the purchase of Omnition for an undisclosed amount in calendar 2019 and the purchase of Phantom for $350 million in calendar 2018. Omnition, in conjunction with SignalFx, supports monitoring and logging of data in apps using more modern architecture (eg. microservices) and is incorporated in Splunk’s Observability Suite; Phantom supports security operations via automation and improved efficiency. While it may still be early to fully determine the success of its largest acquisition, SignalFx, we believe that these strategic acquisitions have generally been accretive to Splunk’s top-line as they add new capabilities to the firm’s product suite and support an expanding range of use cases. We expect management to continue to pursue small acquisitions in the future to supplement its investments in organic growth and build out a comprehensive data analysis platform
We assign Splunk a fair value of estimate of $164 per share, implying a 2021 enterprise value/sales multiple of 10 times.
Within our base scenario, we expect revenue to grow at a compound annual growth rate of 25% through fiscal 2026. This growth will be a result of increased usage of Splunk’s products by existing customers, as well as an increase in new customers (we expect a 13% CAGR over the next five years). While approximately 39% of Splunk’s revenue currently comes from cloud services, we expect this number to grow in later years as Splunk completes its pivot into becoming a cloud-first company; we expect cloud services to constitute 91% of total revenue by the end of our explicit forecast period. This shift to cloud will propel customer growth as we move into a cloud-driven economy, enable more efficient cross-selling and support additional use cases. As pressure from the cloud transition eases, we believe Splunk can enjoy strong long-run top-line growth; this will be supported by a ramp-up in pandemic-induced business digitization efforts.
Historically, Splunk has reported strong GAAP gross margins, averaging 80% over the last five fiscal years; this is within the 75%-85% range seen for a typical SaaS company. However, the cloud transition will pressure future margins, as Splunk is seeing higher costs associated with cloud infrastructure. Over time, scale and cost mitigation strategies (eg. stateless indexes) will help reduce some of these expenses. We expect Splunk to report an average GAAP gross margin of 74% over the next five years. However, as the firm scales and the cloud transition wraps up, we expect this to approach the low-to-low-80s both on a GAAP and non-GAAP basis.
Splunk should benefit from operating leverage, and we expect expansion in non-GAAP operating margins into the mid-teens by fiscal 2026. While sales and marketing costs averaged 63% of revenue over the last five fiscal years, we expect this to decline to 41% by fiscal 2026, serving as a key driver of scale-based leverage. Over time, we should see this translate to excess returns on the bottom line. While operating margins are yet to turn positive, we expect increasing scale to enable that possibility in the longer term.
27 Apri 2021
Narrow-moat Splunk reported better-than-expected first-quarter results that beat our expectations and guidance on a top-line basis. While our long-term thesis on Splunk facing a healthy growth runway remains intact, we see greater uncertainty regarding the bottom-line as the cloud transition wraps up. As a result, we are lowering our fair value estimate for Splunk to $164 from $212, but continue to view shares as undervalued at the moment. In spite of increased uncertainty, the cloud transition continues at a solid pace, with over 50% of software bookings coming from the cloud. We expect sustained cloud penetration, a growing robust product suite, and strong execution to lead to healthy long-term growth.
First-quarter revenue increased 16% year over year to $502 million. After several quarters of declines in the top line as a result of the cloud transition, accelerated adoption of Splunk's robust product suite, as well as growing cloud traction have resulted in revenue growth once again. As cloud revenue is recognized ratably over time rather than up-front (as with term licenses), Splunk has been facing top line pressure for some time. This has been compounded by falling contract durations as a result of macroeconomic uncertainty and growing cloud demand. However, as we predicted, Splunk is now exhibiting growth in the latter part of the transition, and we expect this to persist in the future. First-quarter cloud revenue grew 73% year over year to $194 million, with cloud annual recurring revenue, or ARR, up 83% over the same period. This contributed to a 39% increase in total ARR. Even though management has withdrawn some long-term targets, healthy growth in cloud adoption has Splunk still on track to wrap up the cloud transition sooner than previously expected.
March 04, 2021
Narrow-moat Splunk reported strong fourth-quarter results that surpassed our expectations. The firm's cloud transition continues to be a success, with cloud products making up over half of all software bookings in the latest quarter; Splunk is now a cloud-first company. In addition, Splunk closed several sizable deals that had slipped in the third quarter as a result of pandemic-related headwinds, and management stressed that they are no longer seeing similar impacts on the timing of deal closures. This is in line with our long-term view as we expected such delays to be temporary and still see healthy growth in the cloud alongside an expanding robust product set supporting the firm's long-term prospects. As a result of strong execution combined with the time value of money, we are raising are fair value estimate for Splunk to $212 from $208. With shares trading at $150 after hours, we recommend investors capitalize on the firm's discounted price and consider investing.
Fourth-quarter revenue declined 6% year over year, with full year revenue down 5% to $2.23 billion over the same period. This was mainly a result of volatility in adoption of term licenses due to the pandemic as well as the firm's transition to the cloud. As cloud revenue is recognized ratably over time rather than up-front (as with term licenses), Splunk has been facing top-line pressure for some time. However, we expect that as the cloud transition matures, the firm should see predictable, subscription-like revenue streams. Fourth-quarter cloud revenue increased 72% year over year, with full-year cloud revenue up 77% year over year to $554 million. Cloud ARR came in at $810 million for the quarter, increasing 83% year over year. This contributed to a 41% increase in total ARR. Even though management has withdrawn long-term guidance, healthy growth in cloud adoption has Splunk still on track to wrap up the cloud transition sooner than previously expected.
Nupur Balain Dec 03, 2020
Narrow-moat Splunk reported weaker-than-expected third quarter results that fell short of both our and S&P Capital IQ consensus estimates. Even though the cloud transition continues to be a success, pandemic-linked macroeconomic factors and the revenue recognition impact of the shift to the cloud dampened top-line results. Due to business conservatism linked to economic uncertainty, several seven- and eight-figure deals that Splunk expected to book in the third quarter were pushed into the next quarter and beyond. Management pointed to external macroeconomic factors rather than weaker sales execution or loss to a competitor as the main cause of this delay in bookings. Even though Splunk has closed a few of these deals early in the fourth quarter, there still remains a degree of uncertainty about the timing of closing other remaining deals. Due to pandemic-linked uncertainty, management also withdrew long-run annual recurring revenue, or ARR, guidance. In spite of near-term headwinds, our long-term outlook remains unchanged as we expect Splunk to still be able to execute on its cloud strategy and continue to develop its holistic platform to expand use cases and generate healthy user growth. As a result, we are maintaining our fair value estimate of $208. With shares down as much as 19% after hours to $168, the sell-off might offer investors an attractive margin of safety.
Third quarter revenue declined 11% year over year to $559 million compared with S&P Capital IQ consensus' estimate of $616 million. This surprise was mainly a result of the aforementioned slowdown in bookings as well as a faster-than-expected cloud transition. As cloud revenue is recognized ratably over time rather than up-front (as with term licenses), Splunk has been facing top-line pressure for some time. However, we expect that as the cloud transition wraps up, the firm should see predictable, subscription-like revenue streams
Nupur Balain Dec 03, 2020
Narrow-moat Splunk provides software solutions that enable businesses to gather and analyze vast quantities of data (Big Data) generated by complex operations and to derive meaningful insights from it. The firm’s software primarily addresses use cases in three core areas: security, IT, and observability. Splunk is currently undergoing a rapid cloud transition, becoming a cloud-first company as of the latest fiscal quarter. This transition has accelerated due to macroeconomic factors and should allow the firm to remain competitive in a fragmented space, especially as business needs become more complex and data usage grows. As a result, we are raising our fair value estimate for Splunk to $208 from $200 and maintaining our narrow moat rating. We are downgrading Splunk’s moat trend from positive to stable and maintaining a high uncertainty rating due to strong competitive pressures and uncertainty about the cloud transition.
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