Splunk: Too Little Upside Potential
Summary
- Splunk's revenue growth rate of 10% for fiscal 2021 is not likely to be met. Indeed, Splunk is likely to pull its fiscal 2021 guidance.
- Splunk's ARR is not the same as total revenues.
- This investment remains overvalued at more than 8 times forward revenues.
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Investment Thesis
Splunk (NASDAQ:SPLK) is a cloud platform that allows customers to harness the value of their data. And no matter how attractive and promising this may sound, this rhetoric is not being translated into its financials.
Before COVID-19, Splunk's revenue growth rates were already pointing towards deceleration. The bullish argument has been that as Splunk migrates its customers towards a subscription-based business model, there is expected to be a period of deceleration and that Splunk should bounce back next year.
But I fail to buy this argument. Here's why:
To avoid confusion please note: Splunk's fiscal 2021 ends in January 2021.
Upcoming Earnings Report Will Be Key
We are approximately 2 weeks away from Splunk's Q1 2021 earnings report. This report will show just how realistic its full year 2021 guidance has been. In the past, many investors positively charged that Splunk was low-balling its 2021 revenues to allow for plenty of room for beating estimates; but I do not believe that to be the case. In fact, I suspect that Splunk will pull its 2021 guidance.
However, regardless of whether or not its guidance ultimately gets pulled, it shows that Splunk was on target to post just 10% of revenue growth in fiscal 2021.
Again, the thesis is that Splunk is taking its customers away from one-off licenses, towards a subscription-based business model. This means less revenue upfront but more stability and predictability for Splunk as it books that revenue pro-rata.
Indeed, herein lies the whole bullish thesis: If Splunk is able to successfully migrate its customers away from one-off purchases, towards being locked in over a period of years, then this investment could be rewarding at a certain valuation (more below).
What Is Defined As High Growth?
When Splunk had its earnings call at the start of March, CEO Doug Merritt was bullish about the company's near-term prospects. However, we obviously know what happened globally in the second half of March.
Thus, at the time, Merritt noted that he believed that in fiscal 2022 (next year), Splunk should rapidly increase its revenue growth rates from this year's 10% all the way up to the high 20%s growth.
Source: Author's calculations
Consequently, readers should attempt as much as possible to discern in the upcoming earnings call, just how realistic this target will be. Objectively, even the most bullish shareholders would probably admit that in fiscal 2021 (this year), Splunk is not likely to reach 10% year-over-year revenue growth rates. What makes me say so?
IBM (IBM) is noted in Splunk's 10-K as being one of its main competitors in a few different avenues. Furthermore, we have recently noted in IBM's earnings how challenging the IT market is looking currently, and how business intelligence vendors are struggling. I believe that Splunk could be similarly affected as its customers cut back on all non-essential IT spend.
ARR Is Not Total Revenue
Further complicating the overall picture, Splunk points investors towards its 40% ARR CAGR over the next three fiscal years.
To be clear, this ARR is not total revenue. This ARR is simply for its software revenues or approximately 70% of its total revenue. Put another way, this ARR amounted to just $1.7 billion in fiscal 2020, meaning this potential is already priced in.
Valuation - Not Enough Upside Potential
As stated throughout, Splunk has positioned itself as a fast-growing company. However, aside from this rhetoric, its total revenues are not actually growing that fast.
Presently, investors are considering paying approximately 9 times trailing revenues as a strong bargain opportunity. However, this is a trailing metric. We know that during the end of March and early April, many companies have had to decrease technology spending as their particular sectors compress in the face of the global recession.
Indeed, looking ahead, I doubt that Splunk will reach its $2.6 billion revenue guidance. However, assuming that Splunk does indeed guide for $2.6 billion in revenues, this would imply that investors are paying 8 times forward revenues for a company that has not been able to generate any profits thus far.
The Bottom Line
Investors have been seduced by Splunk's high ARR narrative while forgetting that ARR is not Splunk's total revenue. Splunk's ARR amounts to just 70% of its total revenues.
Meanwhile, investors are paying more than 8 times forward revenues even though its revenue growth rates don't look all that appetizing at just 10% for fiscal 2021.
With so many vastly better investment opportunities elsewhere in the market, investors are overpaying for this investment.
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This article was written by
Michael Wiggins De Oliveira is an energy specialist whose primary focus is capitalizing on “the Great Energy Transition” - the confluence of decarbonization, digitalization with AI, and deglobalization - to achieve greater investment returns. Through his 9+ years analyzing countless companies, Michael has accumulated outstanding professional experience in the energy sector and a following of over 40K on Seeking Alpha.
Michael is the leader of the investing group Deep Value Returns. Features of the group include: Insights through his concentrated portfolio of value stocks, timely updates on stock picks, a weekly webinar for live advice, and "hand-holding" as-needed for new and experienced investors alike. Deep Value Returns also has an active, vibrant, and kind community easily accessible via chat. Learn more.Analyst’s Disclosure: I/we 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.
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