Splunk: Does It Have What It Takes To Return To Profitability Amidst Its Cloud Transition?
Splunk (SPLK) has been a bit of a head scratcher for investors over the last couple of years. Coming into the pandemic, when tech stocks roared due to the belief that the secular growth associated with things like cloud expansion, SPLK shares benefitted. The company traded down to below $100/share during the worst of the pandemic sell-off last March before rallying strongly to highs above $225/share during September of 2020. And yet, since then, SPLK has experienced a precipitous sell-off with shares hitting their new 52-week lows of just $110 in early May of 2021. SPLK has popped a bit off of those lows throughout June and now sits at $141.24. But, that’s a far cry from its highs. With SPLK trading with an approximate 37.5% discount to its 52-week high, we wanted to dive into the recent research reports provided by the 4 and 5-star analysts that the Nobias algorithm tracks to see whether or not this is a dip that investors should consider buying.
When investors hear terms like “big data” or “the cloud” they’re oftentimes confused because of the ambiguity of these terms and the industries that they represent. However, in a recent piece highlighting Splunk’s Q1 results which were posted in early June, Mike Wheatley, a 4-star rated Nobias analyst who writes for SiliconAngle.com, described Splunk’s business model in more detail. He said,“Splunk sells tools that are used by enterprises to monitor, search, analyze and visualize machine-generated data in real time. Essentially, it provides easy access to enterprise’s operational data and delivers insights that can aid in business decision-making.”
Where a lot of the recent weakness has come from in Splunk’s shares is the necessary transition from its slow-growth legacy software sales to a cloud-based software model which relies on the higher margin recurring sales that provide predictable earning’s results that Wall Street loves.
With regard to this transition, Wheatley said, “The company has been steadily pushing its customers to cloud-based versions of its software. That has seen its revenue model change from one that’s based on perpetual licenses to cloud subscriptions, which provide a more predictable income stream. Today’s results show that the company is making good progress in that transition.” During his piece, Wheatley mentioned that Splunk’s Chief Executive Doug Merritt recently had an interview with Barron’s, which focused on this cloud-based transition. Wheatley wrote, “Merritt told Barron’s in an interview that from a technology point of view, the company has more or less completed its transition. All of its software is now available in the cloud, on a subscription basis, he said. However, he said the company still has work to do on the financial side of the transition.”
It’s the speculation that still exists with regard to whether or not Splunk can return to profitability (in 2020, Splunk generated $1.88 in earnings-per-share; however, in 2021, that figure is expected to go negative, with the consensus analyst estimate coming in at -$0.55/share) that is holding SPLK shares down at the moment.
Daniel Newman, a Nobias 4-star rated analyst, recently published an article at futurumresarch.com, which highlighted Splunk’s recent Q1 results. As you can see below, there was a lot of growth to be seen, which has inspired the most recent leg-up in the stock from ~$115 to ~$140. In his piece, Newman highlighted Splunk’s Q1 results by listing these impressive metrics:
Cloud ARR was $877 million, up 83% year-over-year.
Total ARR was $2.47 billion, up 39% year-over-year.
Cloud revenue was $194 million, up 73% year-over-year.
Total revenues were $502 million, up 16% year-over-year.
203 customers with Cloud ARR greater than $1 million, up 99% year-over-year.
537 customers with Total ARR greater than $1 million, up 46% year-over-year.
However, even with so much seemingly strong double digit growth at play, Newman said, ‘EPS is still negative, indicating significant resources being invested in growth, and being slightly worse than estimates, the street was hard on the stock after earnings.” He continued, “Having said that, I believe the company is in the middle of an important pivot and while negative EPS isn’t ideal, shifting to Splunk Cloud, and making the necessary investments to accomplish this is the appropriate course of action at the current juncture.”
Newman noted that Splunk did not provide full-year guidance in the Q1 report, but looking at the recent results, he came away with a bullish outlook. He concluded his piece saying, “Also, the overall revenue growth YoY was solid and the EPS loss isn’t atypical of a high-growth company. Especially one that is in a notable transition from licensing to subscription models. The trend lines are encouraging and the growth in adoption of Splunk’s technology and the strong conversion of revenue to ARR should traverse in the next fiscal year returning the top line to growth.
Nicholas Rossolillo, a Nobias 4-star rated analyst who publishes content at The Motley Fool, recently penned an article which highlights the potential pros and cons of a SPLK investment. He began his piece showing the conundrum that SPLK presents investors, saying, “Part of the reason for the underperformance is that Splunk is undergoing a transition to the cloud, and said transformation is creating some headwinds for the company's overall growth profile. It is still growing, but is valued far cheaper than its peers. On one hand, it might pay off to be patient with Splunk -- but there are also reasons to cut bait and invest elsewhere in the data analytics and observability software space.”
Rossolillo notes that SPLK’s attempt to transition the majority of its revenues to the cloud space has created an odd discrepancy between its cloud revenue and its overall sales. He said that SPLK’s first quarter revenues increased by 16% year-over-year, which was great considering that in 2020, the company posted -5% revenue growth compared to 2019’s total. However, when investors dive into the Q1 results, they’ll still see major headwinds when it comes to Splunk’s turnaround attempt.
Rossolillo said, “Within this headline result, the company actually reported annual recurring revenue (ARR) of $2.47 billion, a 39% year-over-year increase. Why the big discrepancy? ARR accounts for all sales on an annualized basis, including the company's cloud-based products and older legacy software.” He continued, saying, “Put simply, Splunk Cloud is growing at a rapid pace (cloud-only ARR increased 83% year over year in Q1), but its other service revenue is stagnant at best. And since cloud ARR was just over one-third of the total in Q1, overall revenue growth is much slower than the ARR metric would indicate.”
Rossolillo doesn’t expect to see the disconnect between cloud and legacy revenues to disappear in the near-term and therefore, the headwind that stagnant legacy sales present is likely to continue to weigh on the stock’s valuation. Yet, because of Splunk’s big sell-off throughout 2021, the stock now trades at a discount to its smaller, yet faster growing peers. And therefore, he believes that there is opportunity, assuming that Splunk’s management can execute and transition a larger percentage of the company’s sales into the faster growing cloud space in the coming years.
With regard to his personal position, Rossolillo said, “Its smaller peers trade for 20 times trailing one-year sales or more -- although they are growing at a faster clip. So I'm choosing to be patient with my existing Splunk position for now.”
More recently, on June 22, 2021, Splunk investors received good news in the form of famed technology investment company, Silver Lake, buying $1 billion of Splunk’s convertible notes as an investment in the company which is meant to help its cloud transition.
n the press release associated with the investment, Merritt was quoted as saying, “We’ve significantly evolved our business since we began our transformation to become a cloud-first company over two years ago, and today’s announcement reaffirms the strength of our business fundamentals, cloud strategy and high-growth trajectory,”
Nicholas Ward is a Senior Investment Analyst at Wide Moat Research. He has spent the last 8 years writing about the stock market at various publications, including Seeking Alpha, The Street, Forbes Real Estate Investor, Sure Dividend, The Dividend Kings, iREIT, Safe High Yield, and The Intelligent Dividend Investor.
The SPLK CEO continued, saying, “Silver Lake has a strong reputation and track record of investing in innovative technology companies, and with their support, we are accelerating toward our goals as we deliver the most scalable and powerful data platform in the cloud.”
Daniel Sparks, a Nobias 4-star rated analyst who writes for The Motley Fool, published an article highlighting the 11.5% jump that the investment news inspired in SPLK shares. In his piece, he highlighted Splunk’s apparent plans for the incoming Silver Lake cash saying, “Interestingly, Splunk will not use the proceeds from the investment only to fund its transformation and growth initiatives but also to improve its capital structure and potentially even repurchase shares. Along with this transaction, Splunk's board announced the authorization of repurchasing up to $1 billion of its stock. The repurchase plan, however, is primarily intended to offset any dilutive effect of the notes.”
Overall, it appears that the 4 and 5-star rated analysts that Nobias tracks are in Silver Lake’s bullish boat. Since the start of June, we’ve seen 22 reports published on SPLK shares. Of those reports, 17 came with “Buy” ratings, compared to 3 “Neutral” sentiment reports, and just 2 “Sell” ratings. We’ve seen 11 analysts update their price targets for SPLK shares. Those fair value estimates range from $125 to $200 and the average amongst them is $163.09. When looking at the average price target from the credible group of analysts that we track, we see that upside potential from today’s $141.24 share price appears to be approximately 15.5%.
Disclosure: Nicholas Ward has no position in any stock mentioned in this article. Nicholas Ward wrote this article for Nobias at their request with a view of giving investors a balanced perspective based on the writings of Nobias highly rated analysts and bloggers. Nobias has no business relationship with any company whose stock is mentioned in this article and does not have a position in this stock.
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