Splunk Delivering When Other Techs Are Not

By Stephen D. Simpson, CFA | May 31, 2013 AAA

It's hard for a company to completely shield itself from a difficult macro climate, but having a solid product for a burgeoning (and heretofore untapped) market is a pretty good way to try. To that end, Splunk's (Nasdaq:SPLK) machine data processing software/services are giving companies capabilities they haven't had before, and they seem willing to pay for it. While the valuation here looks pretty heated, I can appreciate the appeal of a high-growth stock at a time when many other techs have stalled.

SEE: A Primer On Investing In The Tech Industry

Fiscal Q1 Earnings Come In Solid
Given the valuation and the nervousness in the tech sector, Splunk investors needed to see a good earnings report, and that's what they got. Reported revenue rose 54% this quarter and beat expectations by about 5%. License revenue was up a strong 48%, while maintenance revenue improved 64%. Although billings growth (up 37%) and deferred revenue growth both decelerated, the prior quarter was boosted by a particularly large deal.

Margins were a more mixed situation, at least in an absolute sense. Gross margin was basically steady on a year-over-year basis, while the operating loss expanded by more than 50% (to over $5 million). Marketing expenses rose more than 70% from the year-ago level (on a GAAP basis), and while the company is clearly looking to support its growth efforts, the SaaS aspect to the business does make margin leverage a little more questionable for the long run.

SEE: How To Decode A Company’s Earnings Reports

Separating From The Pack
There really aren't public-traded comps that do exactly what Splunk does, but Splunk is nevertheless significantly outpacing those companies that are in its markets and the larger network management/services business. Compared to TIBCO (Nasdaq:TIBX), the software businesses of Hewlett-Packard (NYSE:HPQ) and IBM (NYSE:IBM), and even SolarWinds (NYSE:SWI), Splunk's revenue growth is truly exceptional.

Splunk continues to sign up customers at a rapid pace. The company logged 81% more deals worth $100,000 or more, and this quarter makes more than three years worth of quarters where the customer base grew by more than 35%. What that means is that in a market where IT managers are cutting back on databases, analytics, assorted middleware, network management tools, security and almost everything else, they're still willing to give Splunk's machine data analytics services a try.

Establishing Value Still Critical
What Splunk does – collecting, indexing, storing, and analyzing unstructured data like syslogs and applogs, but also items like GPS data and RFID scans – is worthwhile. This data is useful not only for diagnostic and network optimization purposes, but there are actual valuable business insights to be drawn from it.

Or so the thinking goes. The problem with the unstructured data opportunity is that it hasn't been very easy to systematically collect and analyze it before (apart from homemade solutions), so it's hard to make sweeping statements about what the data is worth to enterprises. Still, with so many enterprises now generating such enormous amounts of data on a day to day basis (and spending millions on data analysis software from companies like IBM, SAP (NYSE:SAP), and Oracle (Nasdaq:ORCL), it seems like Splunk has a real opportunity to deliver value here to clients.

What's more, I like how the company operates its business. In its relatively short history, management has already established a reputation for outperforming, and I like that the business is structured to incentivize sales reps to push for maintenance renewals. That said, the company's software/services are not cheap and the company could be vulnerable to some price competition. What's more, there's a SaaS component to the business that could compromise margin leverage as we've seen at other companies like Salesforce.com (NYSE:CRM) and Red Hat (NYSE:RHT).

SEE: A Look At Corporate Profit Margins

The Bottom Line
I'll be surprised if Splunk doesn't get acquired (IBM would seem like a logical buyer), but Splunk is nowhere close to cheap. Even ten years of cagr near 30% don't come close to generating a price target in line with today's price. Now, I'm well aware that growth/momentum investors tend to be valuation-insensitive when a company is growing (and outperforming) like Splunk has been and has such a potentially large addressable market, but I just can't subscribe to that sort of investment philosophy. So while I really do like the Splunk opportunity, I can't see myself buying these shares unless I just want to set aside some “mad money” and take a gamble with a fast-growing early mover in a potentially lucrative market.

At the time of writing, Stephen D. Simpson did not own shares in any of the companies mentioned in this article.

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