No matter how hard we try to follow best practices – diversify, don’t try to time the markets, use dollar cost averaging – we always find ourselves reverting back to bad habits. Of the 32 positions we’re holding right now, two of them we engaged in a bit of market timing on – Alteryx (AYX) and Splunk (SPLK) – which dropped -40% and -25% respectively at which time we went long. Today, both of those positions are in the red, which means we’re accumulating them at an even bigger discount. Today, we’re going to talk about why Splunk’s annual revenues appear to be falling along with their stock price.
People always Google “why is stock price X falling” when things start going south. Even Google can’t answer that question. What investors should be asking is “has my thesis changed?” In the case of Splunk’s falling stock price (down -42% from a peak of $219.33 a share), we want to make sure our thesis hasn’t changed as we continue accumulating at these prices. The first thing we want to look at are some basic financials.
Splunk’s Basic Financials
Looking at the annual data shows a company that’s been rocked by The Rona with revenues declining about -5.5% in 2021 (Corporations use something called a fiscal year, which means their accounting year can be finished even though the actual year isn’t. Yes, we think it’s mental too.)
But, if we look at the quarterly numbers, we see a trend that’s far more encouraging. Revenue growth is back, and cost discipline is reigning in losses.
Our investment methodology focuses on revenue growth as one of the most important metrics to watch, so we’re happy to see that’s back on track. If we annualize Q4-2021 revenues (4 * 745 million) we get $2.98 billion. That means if the next three quarters are at least $745 million in revenues, Splunk will handily beat last year’s revenues by +33.6%. So, there’s a path to continuing revenue growth. We can also use these numbers to produce our standard valuation ratio – market cap / annualized sales – which gives us (21 / 2.98) a value of 7. To put that in context, here’s a table that shows relative valuations of enterprise AI/big data stocks using our valuation ratio (lower is better).
|Company Name||Revenue Data||Annualized Revenues
It’s easy to argue we’re buying Splunk’s future revenue growth at a fair valuation relative to its peers.
Has Our Splunk Thesis Changed?
It’s been about 14 months since we last wrote about Splunk, a company that makes sense of “machine data” which is basically the data exhaust that happens as a result of running loads of enterprise apps in an organization. The product is priced primarily on the amount of data indexed, which is a great business model to have when the amount of big data on this planet is expected to grow exponentially with technologies like global internet, 5G, and IoT.
When checking in on a company, we’ll look at their latest regulatory filings to see what meaningful events have taken place. Splunk’s most recent 8-K is worth mentioning.
The CTO Departs
A few weeks ago Splunk traded lower on news that their Chief Technology Officer (CTO) handed in his resignation so that he could join Menlo Ventures as Partner leading the charge in early-stage investments. Says the press release by Menlo:
While CTO of Splunk, Tim oversaw the company’s shift to the cloud. He was responsible for 10 of Splunk’s acquisitions (SignalFx, Omnition, Phantom Cyber, Victorops, Streamlio, Plumbr, Flowmill, Rigor, Rocana, and SignalSense) and also worked with Splunk’s venture capital arm.
The fact that he was poached by a venture capital firm to take his career in an entirely different direction isn’t devastating news. Provided there’s no internal turmoil going on at Splunk (it did appear he may have blindsided them with the news), then it just means the company needs to find a successor for this critical role. While some analysts downgraded the stock because of this, it’s a temporary setback which a solid management team ought to easily navigate.
The Latest 10-K
The best way to start learning about a company is with two documents – the latest 10-K and investor deck. Always start with the 10-K, paying special attention to the “risks” section. Then, check out the investor deck to see how they’re painting the bigger picture.
In their 10-K, Splunk talks about shifting from selling licenses to cloud subscription agreements. In other words, they’re making it a simpler business for investors to understand – software-as-a–service (SaaS) which commands a premium in the market. The percentage of revenues attributed to cloud-based subscriptions increased from +13.2% in 2020 to +24.9% in 2021 as seen below.
Since license revenues are being cannibalized by cloud services, the whole thing becomes rather confusing. It may make sense to focus on overall revenue growth while they navigate this transition.
While no customer accounts for more than 10% of total revenues, sales through Splunk’s top two partners represented 41% of their revenue in fiscal 2021. That’s a risk. So is the nearly $4 billion in debt the company has on their books, though that’s offset by cash and cash equivalents of $1.8 billion. Revenues are expected to be volatile as they transition to cloud-based subscriptions, but that doesn’t appear to be a problem thus far.
Splunk lost nearly $1 billion in 2020. If that continues, they’ll need to raise cash after a few years – either with debt, or by diluting existing shareholders. The quarterly chart above shows consistency which translates into good financial controls in the organization. We need to let them get on with it and we’ll continue accumulating. The next time we check in with the company, here are some of the key metrics we’ll look at:
- 2022 Revenue growth – anything around $3 billion and we’re smiling
- Progress moving from license model to cloud subscriptions – cloud is around 25% of revenues now and over 50% of new bookings.
- CTO replacement – sooner they get this sorted the better
If you’re thinking about opening a position in Splunk, don’t try and time the market. Just establish about a quarter of a position and slowly accumulate over time. If tomorrow the stock falls to $99 a share (a -22.65% drop from today’s price of $128 a share), don’t start kicking the dog. It’s simply an opportunity to add to your position while lowering your overall cost basis.
There’s an $81 billion total addressable market (TAM) that Splunk’s chasing and they’ve only captured around 2% of it so far.
Seems like there’s lots of room for further growth if they keep executing as they have been.
The fact that the market keeps on tearing upwards doesn’t make us happy when we’re trying to buy assets. That’s why we prefer to buy growth assets that are depressed. If we’re down -20% or more on a position, we’re accumulating, provided the thesis hasn’t changed. Our views on Splunk haven’t changed at all. There are some risks to keep an eye on, some metrics to watch, but other than that, we won’t be losing any sleep over Splunk’s falling stock price.
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