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Summary

  • Participated in the acceleration of data mining pure plays in 2013.
  • The company has executed a solid business plan with its disruptive technology in operational intelligence.
  • Based on traditional econometrics, the company seems overvalued at this juncture.
  • Macro headwinds and a lack of accelerated revenues could cause the equity to fall further.

Mining and analyzing unstructured machine data is a business practice that's here to stay. Last year was a huge year for many small cap "Big Data" stocks. Splunk (NASDAQ:SPLK), Tableau Software (NYSE:DATA), and Datawatch (NASDAQ:DWCH) doubled, and even tripled in value. Much larger competitors in the business intelligence arena didn't fare so well. EMC (NYSE:EMC), IBM (NYSE:IBM), Oracle (NYSE:ORCL), and SAP (NYSE:SAP) had lackluster performances in a year that the S&P 500 was up nearly 30%. That said, the smaller data analytic securities appear to be overvalued, most notably Splunk.

The Company

Splunk is the undisputed leader in operational intelligence of the data analytic pure plays. Its software detects gridlock in a corporation's networks, and can massage data in innovative ways to improve organizational performance. CEO Godfrey Sullivan talks about two examples in the most recent conference call:

One of our large customers is analyzing the position and performance of fuel tankers on some of the world's most dangerous roads, proactively monitoring for speeding, illegal fuel transfers, breakdowns and hijackings. Additionally, a large U.S. government contractor is using us to analyze its sensor data from industrial facilities to prevent dangerous accidents in handling hazardous materials.

To paraphrase the most recent 10-K, the core of Splunk's software is a proprietary machine data engine that enables dynamic schema creation on the fly. End users can run queries without having to understand the structure of the data. Splunk complements the core product with additional content in the form of apps or add-ons that can be deployed on top of the main data engine. It doesn't require customization, long deployment cycles or extensive professional services commonly associated with traditional enterprise software applications. It works like a browser, much like Google's (NASDAQ:GOOG) Chrome.

Last quarter, Splunk added 500 new customers, upping the total to 7,000 worldwide. This includes roughly 60 of the Fortune 100. Although this is a significant penetration of the upper echelon in business, the statistic is somewhat misleading. Those 60 companies don't encompass the entire organization, but may represent just a department or two for each specific entity. Nevertheless, Splunk is making inroads with its disruptive technology.

If this is just the dawn of the machine data revolution, there is plenty of room for growth. For instance, the company's year-over-year quarterly revenue has grown by over 50% in each of the past four quarters, as reported by Investor's Business Daily. Although this growth may not be sustainable, it may still continue at an above average rate, at least compared to the competition like an IBM.

In reading the prepared remarks in the conference call, you come away impressed by the new and upcoming revenue streams created by Splunk partnerships. These relationships include:

  • A recently launched joint go-to-market initiative with Cisco (NASDAQ:CSCO) focused on simplifying and accelerating threat visibility with the Cisco Identity Services Engine.
  • Conducting an upcoming 20 city road show with Palo Alto Networks (NYSE:PANW), one of Splunk's top security channel partners.
  • Because of Hunk, which is the Splunk analytic for Hadoop, the company has established partnerships with privately held Hortonworks, Cloudera, and MapR.
  • A partnership with Amazon (NASDAQ:AMZN), where Hunk will be offered on the Amazon Web Services marketplace.
  • Post earnings release, there was also a partnership announced with Tableau Software. The combination of the Splunk and Tableau services have limited overlap because the technologies complement each other.

In order to stay ahead of the technology curve, Splunk spends a considerable amount of money on R&D, $41.9 million in fiscal 2013, almost double the $23.6 million spent in 2012. Although fiscal 2014 R&D expenditures won't be released until early April, Splunk has a history of pouring money back into the company for future business development. In addition, what it can't create in-house, it goes out and gets. BugSense was bought in Q3 to enable direct access to data from mobile devices into Splunk. In Q4, the company purchased Cloudmeter so clients can capture data directly from their networks.

Valuation

Splunk had a tremendous Q4 reporting revenue of $99.9 million. Full year fiscal 2014 sales were $302 million, up 52% year-over-year. Although earnings per share for the quarter equaled $0.03, its full year non-GAAP net loss was $3.1 million, or $0.03 loss per share based on a share count of 105 million. The company will probably continue to incur losses, or break even as it plows more money into R&D, acquisitions, and expanding headcount. For example, employees grew by 300 for the full year, making the total 1,000 under the Splunk umbrella.

For fiscal 2015 (the current calendar year), the company provided guidance of $400 million in revenue. In Q1, sales projections are for $78-$80 million, with an operating margin of minus 8%-10%. I believe that it can be safely stated that a young public company like Splunk should not be valued on an EPS basis because it's investing considerable amounts for growth. It probably won't be profitable for awhile, and if it does get into the black, net profits will be negligible. However, Price/Sales can be utilized as a barometer as to how expensive the equity is.

Utilizing Yahoo Finance statistics, we can observe that the Price/Sales for the trailing twelve months is 32. That's extremely expensive for a company that is guiding revenue growth of roughly 33% for the full fiscal year. Price/Book for the most recent quarter is 12.6. Another generous metric. The market cap is a whopping 9.8 billion. The short float as of February 14th is 3.1%, which may have trended lower since the stock has pulled back significantly the last week. Its intraday high was $106 on February 28th, but has sold off this past week to $88. Quite a drop if you were riding the momentum.

Conclusion

My personal preference in investing is growth at a reasonable price. At this juncture, Splunk doesn't fit the bill, although you may make money with the stock going forward. Consensus opinion calls for a $105 price for Splunk during the next twelve months. Many analysts believe it's a "market perform", which means it will trade in conjunction with the overall indexes. The high price estimate is for $122, the low comes in at $78. Depending on who you follow, you can probably still make a profit with Splunk, but the easy money has been made. It rallied from $28 to its current price of $88 in 15 months.

It is of my opinion that the overall indexes are backing and filling right now, and could continue to move sideways for the next quarter. In addition, some market pockets such as biotechnology, 2013 IPOs, and the data mining pure plays have made huge runs, and could be ripe for a sector rotation. Geopolitical issues are always a headwind, especially with Russian invasion of Crimea we are currently experiencing. Combine those opinions with the fact Splunk's revenue growth may be slowing based on the overall expansion of the company, you've got yourself a perfect storm for obtaining shares at a reduced rate.

Source: Splunk: Expensive By Most Metrics