Takeaway: Some risk into EPS this week with sandbagged #s; but the decel is real in our view which makes going Long impossible here

We maintain the view that a) ML hype cycle fueled at least part of the recent exuberant growth at SPLK which does not repeat at the same pace in coming quarters, b) a successful sales re-org driven boost to revenue also does not perpetuate, c) shift to Term + Cloud away from License + Maintenance does not repeat on a forward basis, d) Splunk has done a great job of monetizing the base but has been somewhat stuck in widening the addressable customer opportunity and our checks indicate that continues to be true, e) the company is ramping up the M&A machine and widening the product aperture because it too sees less upside in the revenue growth ahead.

We modify or soften the view around challenges to the business model from competition, pricing, and alternative approaches, which now appear to us more of a medium-term problem rather than a short-term problem.

SPLK | Decel is Real, Timing is Tougher - SPLK 1

In the process of getting punched in the nose every day by the stock going up (the blood is dry now but you can still see the stain on my shirt) we revisited the model and took it apart again. It turns out that in modeling on par with management’s guidance, the Street is too steep on the deceleration, which sets up for a beat and raise topline for Splunk this quarter. Does anybody really believe these sandbagged #s? We don’t think so.

SPLK | Decel is Real, Timing is Tougher - SPLK 2

What does it mean medium term? Our thesis on deceleration of fundamentals will likely play out, but probably not this quarter with estimates so low.

Is Splunk a great company? It isn’t a terrible one. But it definitely has grabbed a big center of attention on the map in software and built a successful ecosystem around it for something that may ultimately be rendered less valuable by new approaches.

The stock is too expensive, by a factor. Even if they can sustain 25% growth into FY21, and we give them the standard 1.4x EV/FCF/Growth multiple for large cap software, the stock is worth ~$100. And we don’t think they can sustain 25% growth into FY21 (CY20). 

Ami, aren’t there better Shorts out there, like bad companies? Splunk is a company who capitalized beautifully on their opportunity, which existed for a period of time. That time is ending, the company knows it and is launching a lot of new product to widen their aperture, & going after the data plane layer (think Hadoop), and the question becomes, is this business model going to stay where they take your machine log data and let you see trends and alerts from it but charge you to own/store/analyze your own data? Hasn’t this window passed by just a margin? And at $20B cap there is no SYMC buying them. Even Cisco would really have to hold their breath to offer a premium here.

SPLK | Decel is Real, Timing is Tougher - SPLK 3

Potential reasons to go Long SPLK here:

  1. Widening the product set from just index for data to more data tools which enable a broader set of users – ok we clearly like this idea but it is early in the rollout and the need to broaden out from indexing we think aligns with our view that the era of strength from Indexing is waning
  2. Better cash flow and revenue in short term than Street – Street is just modeling guidance on revenue and the cash flow thing is weird...but why do they just model guidance? Why can't they model the way they intellectually understand the business model?
  3. Position in the ML cycle – Splunk does have a good early position in the ML cycle however we think much will change as this cycle matures including what companies are willing to pay for, and what they are not willing to pay for

For access to our SPLK | Short Deceleration Black Book from December 2018, CLICK HERE.

Please call or e-mail with any questions.

Ami Joseph

Managing Director

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Yosef Vaitsblit

Analyst

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