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Summary

  • Splunk has an attractive valued-added case for small, medium and large organizations.
  • Incremental information obtained at Splunk Live materially increased the intrinsic value to $52 per share.
  • The technicals are bearish with a support zone at $30-40 per share.

As can happen when a substantial amount of capital flees an asset, Splunk (NASDAQ:SPLK) has become undervalued. While a technical bottom isn't in place yet, the bottom probably isn't far away. I look for solid first quarter and second quarter results to attract bids.

Splunk has a tremendous runway in front of it. The company will likely increase its presence in the Fortune 100. There is definitely room for international expansion. And the company still primarily relies on a couple of products. Management plans on adding capacity particularly adding experienced sales personnel. Most importantly, Splunk solves a major problem for companies by increasing operational intelligence.

Consequently, I think a material reduction of the risk premium and the associated increase in the intrinsic value ($52.33) is warranted.

Recent Developments

  1. Splunk Enterprise 6.1 was introduced and is available for download.
  2. Hunk 6.1 was introduced, which helps businesses understand and analyze data faster than ever.
  3. New York Air Brake (NYAB) is using Splunk Enterprise to index, monitor, analyze, and visualize sensor data from more than 5,000 locomotives, leading to safer railways and significant cost saving for U.S. rail companies.
  4. Splunk App for VMware is generally available. The app provides comprehensive operational visibility into virtualized environments.

Analyst's Note

Splunk develops and sells software that enables customers to collect, index, monitor, and analyze large amounts of data generated by a wide variety of systems, applications, and devices. The company is organized into two business segments: License contributed 66% to revenue in fiscal 2014, while maintenance and services contributed 34%.

Coming off of Splunk Live in New York City, I have a better understanding of the use cases of Splunk Enterprise. For example, the Federal Reserve Bank of New York uses Splunk to improve electronic data security. Also, NBC Universal utilizes Splunk to improve the performance of its websites and applications for the end users; the capabilities, log analysis, weren't available to the firm's IT staff prior to Splunk. The platform has allowed IT staffs to solve problems proactively. Additionally, the business analysis tools allow companies to incrementally increase revenues.

There are a number of ways for Splunk to continue to grow. The company is increasing its channel partners; for example, Splunk is available through Amazon. Companies can find new use cases and that includes developing apps to run on top of the core engine. Splunk continues to add headcount in sales and develop personnel with domain expertise. The company has room to increase its presence within the Fortune 100, as companies can apply Splunk to business analytic, IT operational intelligence, and security problems. While the pace of growth will vary, given the limited competition, Splunk has a relatively clear runway in front of it.

For the year ending (in millions of dollars except per share data):

2013-04

2014-04E

Revenues

57

80

Gross profit

51

70

Operating income

(16)

(16)

Net income

(16)

(20)

Diluted EPS

(0.16)

(0.18)

For the first fiscal quarter, I'm expecting revenues growth of 40% with a gross profit margin of 88%. The operating loss is expected to be 20% of revenues, and the net loss is anticipated as coming in at 25% of revenues. My first quarter estimate is in line with the street, but my full year forecast is about $20 million above the street's forecast. Data usage growth and customer wins are forecasted to drive revenues growth.

The company should continue to have ample liquidity. In terms of cash flows, there could be $25 million of cash provided by operations and $21 million of free cash flow to the firm. In 2014, cash provided by operations totaled $74 million and free cash flow to the firm totaled $65 million. So, there should be excellent growth of cash flows during this fiscal year.

Splunk is expected to post solid growth numbers and cash flows numbers this year. The company has an excellent and potentially sticky installed base, being a majority of the Fortune 100. Management hopefully will be able to further penetrate the market by increasing awareness of the ROI through use-case awareness. Strong cash flows growth and a solid ROI for end users should drive Splunk's revenues into the multi-billion dollar per year range.

Portfolio & Valuation

(click to enlarge)

Splunk is in a bear market of intermediate and primary degree. But there is an excellent support zone a few dollars down. I expect more signs of accumulation in the $30-40 per share zone.

 

Estimated intrinsic value

Forward price multiples based on base case intrinsic value

Optimistic

$71

P/E: -62.18

Base case

$52.33

P/S: 15.51

Pessimistic

$22.43

P/BV: 8.63

  

P/CFO: 64.77

Using a fundamentals-based model that incorporates the company's lifecycle stage, it appears that Splunk is undervalued. After attending Splunk Live and chatting with the IT attendees, Splunk employees and channel partners, I materially reduced the risk premium that I am charging the company, which increased the intrinsic value estimate. Based on my estimate, Splunk is 20% undervalued. To be more specific, I reduced the required return on equity from 10% to 8% as a result of speaking with Splunk's customers, executives, and technology partners; the company's solutions are a value added for several large enterprises, and the competitive environment is favorable. Thus, the estimated price target and the forward P/S multiple associated with that price target increased substantially. The company is currently trading at 13 times 2015's revenues, which isn't a high price for 40-60% annual revenues growth.

General Risks

  1. The share price is likely to remain volatile and investors could lose a portion or all of their investment.
  2. Investors should judge the suitability of an investment in Splunk in light of their own unique circumstances.
  3. A decline in the global economic growth rate and/or a decline in the pace of economic growth in the United States could adversely impact the results of operations and the share price.
  4. The technology industry is characterized by rapid technological change, which could materially adversely impact the results of operations.
  5. Competition in product development and pricing could adversely impact performance.
  6. Incorrect forecasts of customer demand could adversely impact the results of operations.
  7. Higher interest rates may reduce demand for Splunk's offerings and negatively impact the results of operations and the share price.

This section does not discuss all risks related to an investment in Splunk.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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.

Source: The Recent Sell-Off Leaves Splunk Undervalued