A month ago, I told you to add Splunk (SPLK) to your “Hot IPO Watch List.” You’ll recall, the company’s capitalizing on one of the most compelling growth trends in the market. Specifically, the exploding amount of data we create as a society, known as Big Data, to which I alerted you in early December.
Well, the day of reckoning is upon us. Shares begin trading today. “Big deal,” you say? It is, in fact.
Before long, I expect the company to become a household name and a staple in most investors’ portfolios. And ultimately, its IPO should prove to be the hottest of 2012. Yes, even hotter than Facebook’s (NASDAQ:FB) IPO. And here’s why.
Forget Facebook, 'Friend' This IPO Instead
There’s no doubt Facebook’s IPO is going to make the company’s geeky founder, Mark Zuckerberg, a billionaire many times over. Almost instantly. But the same guarantee can’t be made for lowly retail investors in Facebook’s IPO. I say that because Facebook doesn’t deliver a meaningful, or even necessary, service. We can all live without it. (Trust me, we can.)
And it certainly doesn’t help its users derive any economic benefit. Instead, it tries to derive an economic benefit from its users through advertising. I've got news for you. Advertising has been around for centuries. Sure, Facebook represents a new wrinkle on advertising. But it’s not going to change the world or the way we conduct business.
That, my friends, is what makes Splunk different. It is a game changer. Splunk’s software provides companies with real-time business intelligence. And it does so by collecting a company’s data and indexing it on a massive scale, regardless of format or source. Its technology allows companies to search, correlate, analyze, monitor and run reports on this data. All in real time.
Simply put, Splunk is the Google (GOOG) for the business world. Just like we can’t live without Google, businesses are learning they can’t live without Splunk, either.
Case in point: More than 3,700 customers, including over half of the Fortune 100, are now using Splunk’s software. I know. The same amount of companies (if not more) probably uses Facebook. But that’s only because of peer pressure – “Everyone else is on Facebook, so we should be, too.”
To date, though, no company has materially changed its business by simply being on and/or advertising on Facebook. The difference with Splunk is that companies are actually monetarily benefiting from it.
- After suffering website downtime for six straight holiday seasons, Macy’s (M) started using Splunk. And it experienced zero downtime in 2009 and 2010. The result? It avoided revenue loss of $300,000 per incident.
- Splunk’s software helped MetroPCS (PCS) optimize call routing. The result? A savings of more than $1 million per year. Not bad for a software that can be implemented for as little as $10,000 to $30,000.
- Expedia (EXPE) estimates that its use of Splunk to reduce downtime, optimize marketing and conduct deep web analytics has delivered an annual return on investment (NYSE:ROI) of over $10 million.
Like I said, Splunk helps companies derive a real economic benefit. And that’s much more valuable than amassing a legion of Facebook friends, who’ll likely never put a single penny in the company’s coffers.
Good for Business; Good for Investors, Too
The reason Splunk’s so compelling from an investment standpoint is two-fold…
First, it sells a product that sells itself. I mean, what business doesn’t want to use the data it’s already collecting to improve results. Mind you, there are a lot of potential sales out there, too. Remember, Splunk’s software serves a market worth at least $32 billion, according to Gartner.
Second, Splunk boasts a unique business model with significant leverage. While most enterprise software is sold via licenses based on the number of servers or users, Splunk charges customers based on the amount of data they index per day. So the more data Splunk’s software processes, the more sales the company books. And like I told you before, nobody is predicting a slowdown in the amount of data being produced by businesses.
The good news is a sizable chunk of Splunk’s sales are destined to drop to the bottom line. The company’s gross margins check-in at an unheard of 90.4%. For comparison’s sake, Facebook boasts gross margins of just 47.3%.
Only If the Price is Right
Given Splunk’s enviable fundamentals, one critical question remains: How much are shares worth? Underwriters originally planned to price the IPO between $8 and $10 per share. But in a sign of brisk demand, they raised the range to $11 to $13 per share on Monday. When shares begin trading today, I assure you they won’t be that cheap. So how much should we be willing to pay?
If we use price-to-sales ratios for other enterprise software companies as a proxy, we arrive at a valuation of up to $12.16 per share. That suggests shares will be fully valued based on the pricing range.
If we use recent takeovers in the industry – which is justified since Oracle (ORCL) and Dell (DELL) were both reportedly trying to buy Splunk – we arrive at a valuation range of up to $16 per share. That’s still low. Does that mean we should just pass on Splunk? No!
We need to take into consideration that these estimates are based on a snapshot in time. And Splunk’s business is going to look a lot different one quarter and one year from now. Not to mention, Splunk deserves to trade at a premium since it’s increasing sales at a much faster clip than every other company.
So let’s assume Splunk grows sales by 50% in 2012. That’s not a stretch since the company’s grown sales at a compound annual rate of 91% since 2008. And let’s assume the price-to-sales multiples remain the same.If we do that, Splunk is worth up to $23.50 per share based on my estimates.
Bottom line: We need to leave some room for us to profit, so I’d be a buyer of Splunk up to $20 per share.