2023-08-08 08:30:00 ET
Summary
- After a half decade or so of transitioning its business model, Splunk now operates from a position of strength.
- Solid growth and solid free cash flow, alongside what many seem to forget is a giant business, position the company to grow in the decade ahead.
- Objectively, the company has faced obstacles over the last 5 or so years, and I discuss some of those obstacles with you today.
- I believe Splunk is an interesting "deep value" technology investment that could appreciate ~100% in the decade ahead from valuation multiple expansion alone.
- In short, bloodied and battered, I remain bullish on Splunk stock.
My History With Splunk
I'd like to share the following history with you because it provides context for my thinking regarding Splunk Inc. (SPLK) today.
In late 2020, I shared research in which I communicated that Splunk was an attractive investment.
At the time, it appeared that the business was firing on all cylinders: it was within striking distance of completing its transition from a license model to a Software as a Service, or SaaS, business model.
This entailed transitioning customers off of license agreements and into monthly or annual "recurring subscription" contracts, a.k.a., SaaS.
As we considered purchasing Splunk, we were reminded of a handful of businesses that had successfully completed this evolution in the past.
From Adobe (ADBE) to Autodesk (ADSK) to one of Splunk's peers (loosely) Dynatrace (DT), we knew the playbook well, and we were confident in the process.
I state that we were "confident" in the process specifically because the process entailed periods in which these businesses stopped producing free cash flow, and Splunk, at the time of our making it a Top Idea, was not producing free cash flow because it was still in the final stages of completing its SaaS transition.
These transition periods, which will be seen as vestigial looking forward (all new software businesses are SaaS/usage-based SaaS), also entailed a period in which growth stopped.
At the time of sharing the aforementioned research on Splunk with you, the company was experiencing both negative free cash flow and effectively no top line growth, which we saw as normal and part of the process of the transition.
Further, in late 2020, while Splunk found itself completing this transition, the company's former CEO Doug Merritt laid out guidance for shareholders: Splunk would grow at 30% annualized for the next few years.
Within just a couple quarters, Splunk fell short of that guidance, the stock cratered, and the business was thrust into a reset period, from which it would certainly appear it is now emerging, but more on that later.
And so it went: we found ourselves owning a business that was not producing free cash flow while also experiencing cratering growth rates that were falling short of expectations set forth for investors. The entire C-Suite from that period was either fired or left of their own accord; again, more on this later.
Death & Resurrection
But, as we all know so well, businesses are like humans: They go through ups and downs and everything in between. They make mistakes. They come up short. They make errors. They do dumb things. They fail; sometimes spectacularly.
TheQuotes.net
But through these failures, for those tenacious enough, there is often a rebirth: the businesses return stronger, more efficient, and more prepared for the inevitable obstacles they will face again in the future.
The idea could be summarized by the Forrest Gump video I often share.
Following the hurricane; following the great adversity; following the katabasis , gifts are bestowed upon those that have the tenacity to press forward through the storm.
I recently discussed these ideas with you here .
In the case of Chipotle, I believe one of its subsequent gifts, following the "ecolapocalypse," as I call it, was Mr. Brian Niccol, whose leadership was demonstrated during the lockdown period in 2020-2021.
The data below illustrates how well Chipotle performed during that period of turmoil in which rather draconian lockdowns were thrust upon businesses of all kind (except the big ones, naturally):
And, quite interestingly, I believe we're witnessing a similar dynamic play out for Splunk.
To illustrate this, let's walk through some of Splunk's most recent financial data.
Ascension
We grew annual recurring revenue 16% year-over-year to $3.725 billion , $25 million above the guidance provided during our March call. Total revenues were up 11% to $752 million, well above our guidance. We delivered the 16% ARR growth while remaining tightly focused on our expense control strategy, reducing non-GAAP OpEx by 1% year-over-year. At the same time, we delivered free cash flow of $486 million in Q1, up 253% year-over-year and exceeding our guidance by $11 million. Given our progress on operational efficiency, we're increasing our annual free cash flow outlook.
Gary Steele, CEO, Splunk Q1 2023 Earnings Call (emphasis added).
As I mentioned in the bullets, Splunk has struggled to win new logos, and this specifically began in late 2020, around the time they missed their set forth expectations.
That said, the above metrics are quite phenomenal.
We can see that Splunk is now growing ARR at a very healthy rate, and it is doing so while generating very robust free cash flow. Further, it continues to grow its large customers rapidly.
The business of Splunk has been waiting for about a half decade for these metrics to materialize; for the above slide to come to fruition, because, as we discussed, the transition of the business model entailed a period in which the financials were murky.
They are now crystal clear, and we can see through this prism that Splunk is growing and robustly profitable.
For me and for those that have followed me in owning Splunk, we've been waiting for this quarter for the last three years or so. As I shared in our data ops channel recently, I think we should be jubilant that this day has come!
Later on the call, Mr. Steele remarked,
We ended Q1 with 810 customers with $1 million or more in ARR, up by 120 from this time last year and 20 since last quarter. This includes 433 customers with Cloud ARR over $1 million, up 32% year-over-year. Looking at the year ahead and beyond, I remain confident that Splunk is well positioned to continue to drive top line growth while continuing to improve profitability and free cash flow.
Gary Steele, CEO, Splunk Q1 2023 Earnings Call (emphasis added).
We will discuss Mr. Steele, our new CEO, in just a moment.
Growth Of Large Splunk Customers
We grew total ARR by 16% year-over-year to $3.725 billion, which exceeded our most recent guidance by $25 million. Cloud ARR grew 29% year-over-year to $1.815 billion. Cloud DBNRR was 120%, which was in line with our expectations given delayed cloud expansions.
Q1 total revenue was $752 million, ahead of our guidance range of between $710 million and $725 million. Cloud revenue increased by 30% year-over-year to $419 million. In terms of sequential growth, we want to remind investors that our fiscal Q1 has three fewer calendar days than Q4, and three days equates to over $10 million of cloud revenue.
Brian Roberts, CFO, Splunk Q1 2023 Earnings Call (emphasis added).
Splunk Materially Outperforms Guidance And Posts Brilliant Numbers In Light Of Macroeconomic Turmoil
Our Q1 results demonstrate this focus in action as we exceeded guidance across our top and bottom line metrics. We grew annual recurring revenue 16% year-over-year to $3.725 billion, $25 million above the guidance provided during our March call. Total revenues were up 11% to $752 million, well above our guidance. We delivered the 16% ARR growth while remaining tightly focused on our expense control strategy, reducing non-GAAP OpEx by 1% year-over-year. At the same time, we delivered free cash flow of $486 million in Q1, up 253% year-over-year and exceeding our guidance by $11 million. Given our progress on operational efficiency, we're increasing our annual free cash flow outlook.
Gary Steele, CEO, Splunk Q1 2023 Earnings Call (emphasis added).
Notwithstanding Splunk's struggle in capturing new logos, it has produced simply phenomenal results since our original entry point into the business (from a business perspective; not a share price perspective), as the above cash flow data reveals and as the data below likewise reveals:
Splunk Doubles Total ARR Since late 2020
Below, we can see the "transition period" that we discussed towards the introduction of this note:
Splunk Massively Increases Free Cash flow
And, as we can see, Splunk is now firmly, definitively, and sustainably "in the black," i.e., it's now robustly generating free cash flow.
And, lastly, below, we can see that Splunk has guided for very healthy growth; notwithstanding, as we've discussed in the past, YouTube's (GOOG) sales being in decline and Snowflake (SNOW) not growing whatsoever in the month of April.
New Leadership
As mentioned above, the debacle of late 2020 resulted in the entire C-Suite being removed. The CEO, CTO, and CFO were all effectively removed from their roles by the board.
As of today, we have a new CEO in Gary Steele.
I am particularly heartened by this hire because Mr. Steele led Proofpoint for a couple decades, and Proofpoint is a renowned software vendor.
According to ChatGPT,
Proofpoint, a cybersecurity company, was acquired. In April 2021, it was announced that Proofpoint would be acquired by Thoma Bravo, a private equity firm,, in a transaction valued at approximately $12.3B.
So Mr. Steele has a track record of success. I think there's some fear in my mind that they may be positioning for an acquisition, though only time will tell.
We also have a new CFO in Brian Roberts
And we have a new CTO in Min Wang
In Q1, we welcomed Min Wang as Splunk's Chief Technology Officer. Min brings over 20 years of experience in applied research and product development with a focus on AI, ML, data analytics and enterprise cloud. Most recently, she spent more than five years at Google, including three years leading the team responsible for critical components of the company's AI-driven Google Assistant. I'm looking forward to having Min further accelerate Splunk's technical leadership and catalyze the development of more world-class technology.
Gary Steele, CEO, Splunk Q1 2023 Earnings Call (emphasis added).
Ms. Wang is important because we've often likened Splunk to Palo Alto Networks (PANW) circa 2015.
As I remarked in our data ops channel,
So PANW's CTO was key to the thesis over the last decade: while the business lost its CEO, it retained its CTO through the entire journey (during which it traded down to 4x to 5x sales and was thought to be under competitive pressure from upstarts such as CRWD/S1).
Palo Alto Networks Stagnates For 6 Years
Notably, during that period, PANW's platform was routinely called into question. It experienced substantial stock price declines. It did not appreciate for a full 6 years.
Today, quite curiously, the collective wisdom believes it to be the best thing since sliced bread: "It's a comprehensive platform! It's got things that the next gen vendors don't have!"
"Min holds B.S. and M.S. degrees from Tsinghua University and a Ph.D. from Duke University. She has published over 90 research papers in top peer-reviewed conferences and journals and received several distinguished research awards for her work on data management."
I believe, granted Ms. Wang does a good job, that Splunk will experience something similar in the decade ahead.
We're currently at 10 years worth of share price stagnation! The spring is fully coiled!
Concluding Thoughts: A Fascinating Case Study
As mentioned above, Splunk Inc. has struggled to win new logos, and it makes sense when the leadership team was gutted for consecutive years.
That said, there is nothing stopping Splunk from continuing to evolve its holistic platform.
But, over the last few years, it has not had to because it has been able to upsell its current expansive roster of clients new products.
I found this dynamic particularly interesting: Splunk Inc. has more than doubled its total sales over the last few years, while not adding customers at the rate at which it should.
I believe this demonstrates the very attractive nature of the SaaS business model. I believe this demonstrates that, for instance, S1 or Snowflake could grow for the next few years by simply continuing to evolve their platforms and selling new products into their existing client base.
I believe this also illustrates that our companies have vastly longer runways than the market has been giving them credit for over the last six months.
With all of this in mind, we still need Splunk to reach a point where it's adding new logos/capturing new customers consistently. On this subject, I found the following exchange insightful (emphasis added):
Keith Bachman: I wanted to ask about the competitive landscape, and particularly with an orientation around your traditional business, not the observability business. And the context of the question is, you did call out some new logo wins, and I think investors are candidly sort of surprised to hear about new logos with Splunk. And I was wondering if you could just articulate, as you look out over the growth algorithm you had, I mean how much is actually driven by new logos and which would presumably be largely competitive wins, since everything is competitive? But if you could just talk a little bit about the competitive landscape and how important are new logos?
[It is worth noting here that I am personally done buying businesses in this space, especially as of making Datadog (DDOG) a new Top Idea recently at $68/share. I think our companies will do fine, but I am done with the space broadly speaking.]
And then secondarily, you also have -- you've highlighted the SAP partnership, which is a bit different in terms of taking a deep dive with one particular software provider. What drew that conclusion? Is there other relationships that you think will come from -- in competition in SAP? In other words, will you do more specific partnerships with other large software vendors? If you could just talk a little bit about the strategy there and what the implications are.
Gary Steele: Great. I'll let Brian start by talking just briefly about how much new logos represented in our ARR.
Brian Roberts: Yes. So typically, when you look at net new ARR, it's roughly 20%. We see that consistently. We tend to measure that on a trailing 12-month basis because you can see some volatility. But again, that's something that is held now for multiple years.
[This will need to accelerate in the years ahead, though it's not terrible. It's not great, but it's enough at present.]
Gary Steele: And then competitively, in accounts where we're going in and looking broadly at competition, we've had very good success taking out incumbent legacy SIEM solution , so that's been a sales motion that's been quite productive for us.
In those circumstances, the customer will look at a variety of solutions. And I think we continue to demonstrate that we can meet the complex scale requirements that organizations have, that we offer more flexibility than our competitors out in the market.
[This is Palo Alto Networks 101.]
And just the broad set of security capabilities including orchestration and automation, threat intel, broad security analytics, all of these things integrated into a single product is a pretty unique offering that doesn't exist in the market.
[Will they be singing these praises in 24 months when we finally emerge from the recession?]
So, we -- our win rate is quite high, and we do quite well in those new logo environments.
And then going to your SAP portion, shifting gears, going to the SAP portion. One of the things that's super cool here is if you talk to CISOs today, they struggle with visibility into what's happening with SAP. And so, what we've done basically with this app is it increases the level of visibility that security teams have relative to what's happening within SAP, and they can bring that into the broader Splunk environment and drive broader correlations across their entire security footprint. And so, it provides visibility that frankly, they just haven't had in the past. This is -- we're super excited about this. We're happy to be engaged directly with SAP. They're an important partner to us. And could we do this with other vendors? That's possible. But I think if you just look at the history of Splunk, which you obviously know well, we've always been a company that wanted these TAs or apps that allowed for integration of data into the broader Splunk environment. I think in this particular case, it made a ton of sense to do a very strategic relationship and drive a combined go-to market. So, we feel really good about this and excited about the potential here.
In closing, I do not believe the Splunk thesis is dead in any sense.
In fact, I think it's just getting started!
For further details see:
Splunk: Rising From The Ashes