The leader in the enterprise log management, Splunk (SPLK) is one of the few companies in the software space we have liked for some time due to its resilient and fast-growing business. Having landed over 90 of the Fortune 100 companies as its clients so far and reaching over $2 billion of annual revenue last year, the company will turn to the SaaS model to accelerate growth further. Upon the complete transition into SaaS, Splunk will benefit from a higher-velocity customer acquisition process and better pipeline visibility as opposed to its historical contract-based model. We will maintain our overweight rating on the stock.
(source: company’s Q1 earnings call)
Splunk is a deep-moat enterprise software company with ARR accelerating at +40%. Even without the transition to the cloud, Splunk is already one of the most well-performing and most innovative software companies with its ARR accelerating at +40%. Splunk’s core offering is equipped with a patented dynamic log search technology, which can query, ingest, and process heterogeneous data. This proves to be the company’s competitive advantage in the business, given the offering’s capacity to process massive amounts of real-time security, DevOps, and even business-related data. Given the big-data capability and variety of use cases, the company has established a niche in the high-valued enterprise segment. As enterprise customers like Intel, Shopify, Blackstone, Hyatt, Nasdaq, and more have come on board, the total number of orders > $1 million has increased by over 68% to 494 over the last two years.
(source: company’s Q1 earnings call slide)
However, with the company growing at a staggering 40% CAGR to potentially reach ~$5 billion of ARR and ~$1 billion of OCF (operating cash flow) in 2023, it will be harder and harder for the company to move the needle on growth.
Consequently, the shift to the cloud-based delivery model will enable a higher-velocity sales process with better visibility, eventually accelerating overall growth. With the cloud-based delivery model, potential customers will have more frictionless access to onboard themselves into the product, have a look around, and try the product before arriving at the decision-making process: to have a chat with the sales team or purchase/subscribe directly from within the platform.
As illustrated by the hypothetical yet typical user journey, the decision-making process will happen at a relatively shorter cycle, eventually accelerating top-line growth in the long-run. Furthermore, the fact that all these trials are happening within Splunk’s cloud-based platform will allow for a more effective individual user tracking based on various parameters such as features used or usage frequencies, which will result in a more contextual lead qualification process and eventually better pipeline visibility.
There are no major risk factors we see in Splunk at present, though in our experience, its strong value proposition in the enterprise segment has not been to relevant in the mid-size or SMB segments. Within those segments, we have seen various competitive offerings by players like Mixpanel, SumoLogic, Nagios, or LogDNA that target more specialized log management use cases at much more affordable pricing points. As such, Splunk’s recent acquisitions of VictorOps and SignalFx, which possess a more diverse customer base, appear as a lower-risk move to penetrate the lower end of the market while expanding into fast-growing DevOps Incident Management and APM segments.
Given the transition period into SaaS that affects its revenue recognition, profitability, and visibility into the full year, it would be quite challenging to evaluate Splunk from a P/S perspective. The ARR acceleration and the overall progress of the cloud transition, however, have been very impressive. There are not a lot of SaaS companies that can confidently guide a mid-40% growth in ARR, let alone under the current circumstances. Using its expected FY 2021 ARR of ~$2.4 billion as a proxy to its revenue, the Splunk’s P/ARR stands at ~12x, considering its ~$30 billion market cap. However, considering Splunk’s market leadership in log management and exceptional growth, we found 12x relatively moderate considering that other market leaders like ServiceNow (NOW) and Alteryx (AYX) have been trading between 18x and 20x P/S.
Disclosure: I am/we are long SPLK. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.