The best part of the Short case on Splunk is that the company’s once-traditional core product and market are changing with new entrants, new methods, and new pricing structures which undermine Splunk’s traditional grasp on the market and ability to richly monetize this position. The evidence of our thesis was gathered from an examination of the machine log data market dynamics (product in the ingestion, index, analyze market) but could also be seen evidenced from Splunk itself such as Splunk’s increasing P+L reliance on monetization of existing customers rather than growth in ‘land dollars’ and also in Splunk’s own admission of the need to pivot the product aperture and go to market by ramping up the “M&A machine” in the CEO’s own words. At this point, however, the company seems to be able to navigate the change in their core by wrapping acquired and new product around the core and upselling a bundle, and shifting the debate towards new categories such as orchestration. The rest of our thesis was the math of a slowdown based on non-repeating growth factors, which we are getting right with guidance for F1Q20, but not enough, and given the stellar execution of Splunk of late we may not be rewarded for being right on the math.
Could I go Long Splunk here? After all, stocks are two way mechanisms, and if I am covering my Short up 30% it means I think there is similar upside risk, no? I do see upside risk here as the company is proving to have a model that can sustain something like 30% growth, and while the cash flow will be depressed in F20 due to elevated capex plus the ongoing transition to cloud weighing on collections, as they get back to the transition point they will move back towards their pre-cloud OCF margins of ~24% with capex to sales rates sub-5%, and that’s all while still growing at an elevated clip.
Thinking about it this way – the company produced 394 $1MM+ deals in F19, of which there were 24 $10MM+ deals. Taking the face value of this calculation, with the understanding that this type of deal comes almost entirely from expansion spending by existing customers rather than ‘land’ deals, it implies ~$610MM+ revenue from existing in F19 versus ~$360MM in F18, and taking that purely as expansion bookings dollars…using RPO in F18 as my bookings proxy gets a net expansion rate in F19 of 131%. If you start the year with a shot at a 30% revenue growth year, due in large part to the growth of data from existing customers (and in fairness growing use of analytics of that data), then it doesn’t take much incremental selling to be north of 30%. For now, that’s the math. We thought we had discovered a qualitative thesis that would undermine said growth. We didn’t get it this quarter and until it becomes evident, Splunk will rage on.
Typically, it is a tactical mistake to cover a trade like this on heavy news days such as earnings. But I can’t defend the Short intellectually anymore, so I will apologize for a bad rating, and use the brain on new ideas rather than pursue the dance of trading tactics on something where the thesis has worn thin.
Please call or e-mail with any questions.
Ami Joseph
Managing Director
Yosef Vaitsblit
Analyst
