Summary
- Splunk Inc.'s guidance leaves investors wanting more.
- Splunk's ambition to reach a high Rule of 40, comes up short.
- I remain neutral on Splunk Inc.
Investment Thesis
Splunk Inc. ( SPLK ) put out lackluster guidance for the year ahead.
Furthermore, after years of talking about its business model moving to a cloud business, Splunk management now emphasizes that "on-prem and hybrid will both be here for the long haul."
In sum, Splunk was asking investors to buy into one vision for the company, but now it is essentially saying to investors that this transition isn't happening quite as fast as many hoped it would.
And that investors should instead focus on their strong free cash flows. That's perfectly fine. After all, Splunk stock has gone largely nowhere in 5 years. Meaning that investor expectations are quite low already.
Revenue Growth Rates Fully Fizzle, Why?
The Splunk Inc. guidance for the year ahead took me by surprise. Analysts were quite bearish on Splunk's fiscal 2024 revenue outlook, and they turned out to be demonstrably right.
As you can see here, in the months running up to this earnings result, analysts had been lowering their consensus revenue figures.
And as it turns out, either by Splunk's management ''walking down their estimates'' or from analysts' insights, it turns out that analysts ended up in the right ballpark.
For their part, Splunk used its earning call to highlight to the investment community that this lack of near-term growth isn't a demand issue,
[...] but rather that of timing as many organizations continue to utilize on-prem Splunk solutions with longer term plans to shift more of their workloads to the cloud.
Meanwhile, I strongly believe that Splunk's key headwind is its own business model.
More specifically, it's usage-based revenues. Indeed, companies that have a usage-based business model ultimately suffer. Here's why. By having a usage base model, you are basically hurting your customer the more they engage with your platform.
The best I can describe this is like this. Imagine you wanted to spend time on Netflix, Inc. ( NFLX ) and they charged you per minute on the platform. You'd look for alternatives. And Splunk's customers have ample alternatives.
The best companies, for example, Cloudflare, Inc. ( NET ), have a subscription-based model. They want the customer fully addicted to their platform. They are on the same side of the table as the customer. Not on the opposing side of the table.
Other examples that have a usage-based model or consumption model include Snowflake Inc. ( SNOW ), New Relic, Inc. ( NEWR ), and Fastly, Inc. ( FSLY ). Look at how these companies have turned out.
Profitability Profile Requires a Lot of Interpretation
For the year ahead, at the high end, free cash flow margins are expected to come in at approximately 20%. Splunk uses Annual Recurring Revenues plus free cash flow margins to describe its prospects on a Rule of 40 basis. This is how it looks.
Think about this: if we disregard the fact that stock-based compensation ("SBC") is a real cost for the business, in the best-case scenario, looking out to the year ahead, the figure that investors have to latch onto is a 32% combined ratio.
From this point of view, I suspect it could probably take at least 3 or more years until Splunk reaches the highly coveted Rule of 40. Although, we have to be frank, it's likely that Splunk never reaches the Rule of 40 at all.
Perhaps the best way to think about whether or not SBC is a real cost is to discuss this. In the past year, the total number of shares outstanding increased by 17%.
That being said, looking ahead to its fiscal 2024 guidance, Splunk expects its free cash flow line to increase by 67% y/y. Consequently, even if one were to be concerned about Splunk's SBC packages, the fact remains that free cash flow is growing meaningfully faster than SBC dilution.
The Bottom Line
As I've alluded to throughout, Q4 was far from a stellar quarter for Splunk Inc. But given that Splunk stock has gone practically nowhere for 5 years, I don't believe investors were expecting much, if anything, from this quarter.
In conclusion, I remain neutral on this name.
For further details see:
Splunk Earnings: Both Bulls And Bears Can Rejoice