Splunk: Investors Avoid This High-Flying PaaS Company
Summary
- Investors underreact to Splunk's Q4 2020 results and guidance.
- Splunk's 3-year 40% ARR CAGR may not be enough for shareholders to hang onto.
- Investors should avoid this overvalued stock.
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Investment Thesis
Splunk (NASDAQ:SPLK) delivered Q4 2020 results which surprised the market and led to an abrupt sell-off, -14%. The sell-off then worsened as it combined with pervasive coronavirus fears.
However, I contend underlying this volatility, Splunk delivered a thesis-breaking report.
I contend that shareholders are overpaying for a company that is overvalued in the face of decelerating revenue growth rates. Here's why:
High Growth Company Without High Growth Rates
The whole point of investing in a high growth, recurring revenue business model company is that it should have two noteworthy aspects:
- High growth revenue rates (at least 20%); and
- Recurring, stable and predictable revenue growth rates.
With that in mind, please note the graph below:
Source: author's calculations; *** company guidance for 2021 (calendar 2020)
How is this growth rate in any way stable or predictable? We can see that just two years back Splunk was growing its total revenues at close to 40%, and now looking forward to fiscal 2021, it's guiding for just $2.6 billion of total revenue.
Bullish shareholders would retort that Splunk is guiding low to allow for sandbagging. Possibly. Nonetheless, the drop from growing at 40s% two years ago to just 10% is odd.
Management declares that it's nothing to worry about, that this decline in revenue growth rate has more to do with the mix of contracts and its booking of ratable revenue.
In fact, management asserts that once Splunk gets into fiscal 2022 and fiscal 2023, its growth rate should rapidly 'bounce back' into the high 20s% growth rates.
Carrots to Hang Onto?
To give shareholders something to look forward to, management notes that over the next three fiscal years, it is targeting 40% ARR CAGR.
Now, let's break this target down:
Source: Slide 15
The first aspect that is important to note is that its ARR for fiscal 2021 is pointing towards 45% growth. Given that Q4 2020 finished with an ARR of 54%, this marks a significant slowdown.
Source: Slide 9
The next critical aspect to mention is the small print below. According to industry-wide practice, the ARR is a run-rate from Q4 2020 going forward.
So my question is, why is this Q4 2020 exiting run-rate at 54%, but for fiscal 2021 it's down to just 45%? The next obvious question being, what will Splunk's total ARR be in 2022? Common sense leads one to believe it will be sub 45%.
Now, to go full circle, how much conviction will investors have on Splunk's ability to bounce back its total revenues to the high 20% in fiscal 2022?
Strong Cash Flow Business?
Below is another signpost for investors to hang onto:
Splunk is targeting $1 billion of cash flows by fiscal 2023 (calendar 2022).
However, consider this, Splunk acquired SignalFx for just shy of $1 billion in October 2019. We should have minimally expected this acquisition to boost its revenues into fiscal 2021, but that's clearly not playing out.
Thus, my next question, just how much of that fiscal 2023 $1 billion of operating cash flow actually be organic? And is it sustainable?
Valuation - No Margin of Safety
My final argument boils down to a discussion over its current market cap.
A lot needs to go very right for Splunk to reach that $1 billion cash flow target. As the graph higher up notes, thus far, Splunk is significantly cash flow negative and has shown a consistent inability to become profitable.
Hence, my question to readers is whether paying up a $20 billion market cap, for a company that may or may not reach $1 billion in cash flows from operations more than three years out, makes for a worthwhile investment?
The Bottom Line
Splunk's revenue growth rates are steadily declining and not aligned with the narrative of a high growth, steady and predictable business model.
Given its consistent inability to make any profits, I believe investors are pricing in too much hope on its future potential and are highly likely to be disappointed.
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Comments (14)
Maybe I'll be wrong. I'm often wrong.... but I've actually changed my mind about JD and I'm a shareholder now (don't tell anyone else). There again, I'm often wrong. hehehe
Happy first comment.'The revenue multiple is the question. 'I agree.
ADBE 9.9B ARR, $160B mkt cap $332 stock
SPLK 2.4B ARR, $20.6B mkt cap $132 stock