2023-04-06 12:51:27 ET
Summary
- Splunk, the market leader for SIEM expects a slow FY24 with revenue growth of only 9%.
- The TAM for security, monitoring and observability is massive, growing and under penetrated and Splunk can continue to consolidate its lead.
- Splunk has opportunities to leverage its large customer base by expanding its use cases and generating more revenue per user.
- Splunk's operating margins are getting better, it generates gobs of cash and it has started focusing on cost rationalization.
- Commensurate with the slower revenue growth, it's P/S multiple has dropped to just 4. I believe Splunk is a good bargain around $75 to $80.
Splunk ( SPLK ) is the market leader for SIEM (Security, Information and Event Management) with the largest revenue of $3.67Bn in that segment.
SIEM is the collection and monitoring of all event logs across a company's technology stack to take care of Security Monitoring, Fraud Analytics and Detection, Incident Management and Business Service Monitoring, among many others as shown below. Splunk's platform provides tools for its customers' cybersecurity and information technology teams to keep their digital assets up and running through disruptions - essentially making their customer's technology, software and digital systems more resilient.
Often the SIEM segment is also categorized as APM (Application Performance Monitoring) with both having much of the same functions of security, observability and monitoring. The key competitive advantages that stand out for Splunk are its scale and size and its wide range of productions and solutions. As we can see from the slide, they have a wide arsenal of services beyond SIEM. This allows for adoption of new use cases for upselling to embedded customers, a key characteristic of valuable SaaS companies. The laundry list of services is also vital for adding new logos as Splunk needs to expand to negotiate a much tougher selling environment in 2023.
Splunk had a brilliant decade growing revenues at 32% each year from a fledgling $302Mn in FY2014 to the $3.6Bn security behemoth it has become today. Massive needs for security and event monitoring, growth from Cloud Service Providers, Hyperscalers and Work From Home because of Covid-19 greatly boosted demand. However, these catalysts are in the rearview mirror now and according to an excellent article on Seeking Alpha, most Datacenter hyperscalers and Cloud service providers have warned of declining growth and demand. Splunk not surprisingly on its part, too, forecasted only 9% growth for 2023 and at a relatively sedate 15% growth for the next 5 years.
Splunk used to sport a P/S multiple above 13 at one time with a sky high stock price of over $225. Now, its valuation is at a more reasonable 4X sales at $93 per share. Let's take a look at its business and some of the strategic initiatives it is taking to shore up growth, profitability and fending competition from Datadog ( DDOG ) to see if it's worth buying now or on declines.
Splunk's Revenue Segments: Focusing on the Cloud
Splunk Revenue Segments (Seeking Alpha, Splunk, Fountainhead)
Embedded Strategy : Splunk changed its strategy from selling licenses to focus more on multi year cloud SaaS contracts to cement longer term relationships and increase upselling opportunities. Having relationships with key IT decision makers through a cloud based SaaS contract, instead of a license enables Splunk to sell more of its services and increase revenues without the commensurate customer acquisition costs.
As we can see from the table above, Cloud revenues have tripled from $554Mn to $1.5Bn in FY23. Splunk expects Cloud revenues to increase to 50% of total revenues by 2H of FY24. Cloud margins have improved significantly with more revenues from 54% to 66% and as a result, overall margins too improved from 75% to 78%; in line with Datadog's, which has the best margins in the industry. Datadog is about 50% of Splunk's size with its main focus on observability and monitoring.
Strengths and Key Strategic Initiatives
Splunk in its Q4-FY23 presentation forecasted a TAM of $100Bn based on its own estimates and Gartner and IDC Research. With less than $4Bn in revenues there is a long runway ahead for Splunk.
These are the key strategic initiatives planned by Splunk, which should drive revenue and earnings growth.
Adding Use Cases and Upselling : Given the market size, its scalability and its leadership position, clearly Splunk doesn't want to stay within a few narrow categories of security. Instead, it plans to leverage its vast arsenal of services and large roster of clients to keep adding use cases for its customers. Splunk's $ Net Retention Rate of 127% stayed high because of customers adding additional security use cases or adopting broader IT and observability services.
Growing observability . Splunk had a number of marquee observability wins in Q4. From its Q4-FY23 earnings call: Emphasis mine.
We believe observability is a massive growth opportunity for Splunk, and we're making investments to broaden and strengthen our portfolio of enterprise-grade observability solutions that provide monitoring across complex environments. We see it as significant, both in our installed base where customers that have been loyal Splunk core customers. They want to extend their reach into a broader set of applications .
We also went head-to-head with a niche absorbability competitor and won a significant deal in Q4 to help a mobile financial services provider in Asia Pacific, modernize their applications. This provider required visibility and insight across several cloud-native micro services they use to provide secure and accessible fintech. We ultimately won the deal because of our scalability, performance and ability to deliver critical integration between observability and security , combined with our more cost-effective pricing model.
Leveraging Relationships: Splunk, like its smaller counterpart Confluent ( CFLT ) is leveraging its relationship with CSP’s and hyperscalers. Splunk partnered with Accenture (ACN) in getting a multinational automotive manufacturer to expand Splunk into security use cases to enhance the customer's overall resilience. It also won a multimillion dollar targeted cloud migration with a US financial institution, partnering with Amazon Web Services (AMZN) to address fraud and insider threats, besides bolstering business applications and process security.
Leveraging the Hybrid Model - Splunk has been a hybrid player or, On-Prem and Cloud player for a long time, having started out as an On-Prem License Provider. This is actually a big competitive advantage for it compared to some of the younger players. Age before beauty....
From its earning call : Emphasis mine.
The reality is On-prem and hybrid will both be here for the long haul, and Splunk has a strong competitive advantage given our solutions help strengthen our customers' resilience across multi-cloud and hybrid environments. We also believe the current budgetary environment can create opportunities for us as companies look to consolidate the number of tools used across our operations with proven leaders like Splunk.
What we do understand, though, very clearly is that this hybrid world, combining cloud and On-Prem is an architecture that I think we'll see for a very long period of time. And as you've heard from us, we -- by reaffirming our commitment to On-Prem and supporting this hybrid architecture, we fundamentally think will be strategically advantageous to us, and we think we're well positioned over the long haul because of that.
Reducing Costs : Splunk plans to reduce global workforce by about 4% this year. Splunk spent $791Mn, $1Bn and $997 Mn on R& D expenses in FY21, FY22 and FY23, respectively, a whopping 35%, 39% and 27% of sales . In FY24, Splunk plans to hire top talent for R&D only in emerging markets and keep R&D expenses the same as last year, while increasing its impact. With revenues increasing and R&D flatlining this will clearly help margins and go straight to the bottom line.
Reducing Dilution: Splunk expects to meaningfully reduce equity dilution in FY24 relative to FY23 to get to a longer term, lower and sustainable burn and dilution rate and reduce SBC expenses in the future.
Investment Case
Splunk Earnings and Revenue Projections (Seeking Alpha, Fountainhead, Splunk, Wall Street Journal, Nanalyze)
Reasons to Buy
Reasonable P/S Valuation: Having grown at 30% in the past decade from a fledgeling $300Mn to $3.6Bn security behemoth, Splunk is looking at relatively sedate 15% growth over the next 5 years. However, Splunk also has a lower P/S ratio of 4, which reduces to 2.4 in 3 years.
Improving Margins and Earnings : Earnings are expected to grow much faster at 22% because of the operating leverage, which increases with management's commitment to rein in fixed operating costs and rationalize its R&D spend. Splunk spent $791Mn, $1Bn and $997 Mn in R& D in FY21, FY22 and FY23, respectively, a whopping 35, 39 and 27% of sales. With revenues increasing and R&D flatlining this will clearly help margins and goes straight to the bottom line. Splunk's Non GAAP P/E of 32 is high today given poor earnings growth of only 10% in FY24, but this reduces to 21 by FY26, with the PEG going below >1.
Splunk's cash generation is a lot more impressive with $427Mn Cash generated in FY23, but the big improvement is the estimated $785MN in 2024 - about 19% of annual recurring revenue.
Security is a utility: Security has become a utility with Monitoring and Observability of data not far behind for businesses. Splunk is ubiquitous across large companies with 90 of the Fortune 100 companies choosing it. Splunk’s scale is a big competitive advantage.
Upselling: Splunk has become successful in adding use cases, which will clearly widen its reach given the size of its customer base – more use cases per customer is also obviously better for margins.
SaaS business deserves a better multiple : Splunk deserves a better multiple as a genuine SaaS company instead of a pure licensing one, with annual recurring revenues, the capacity to provide managed and value added services and a vast arsenal of software and platform tools.
Scale and high switching costs : Splunk has a $ Net Retention Rate of over 127% in line with Datadog's 130%. Besides, as we can see from the table below, Splunk's estimated 15,000 customers spent an average of $266K each year as compared to Datadog's 22,000 customers who spent significantly less at $95K. 1) That goes to show the scale and size of Splunk's business - there are a precious few providers who can operate at that level 2) Larger customers will tend to be stickier because of the switching costs.
Splunk and Datadog (Seeking Alpha, Nanalyze, Splunk, Datadog, Fountainhead)
I own Splunk and plan to buy more around $80, primarily because I believe tech stocks are due for a correction, as they've had a good run from January. Splunk has risen more than 40% from its $65 bottom and it too should correct with the rest of the market in my view.
For further details see:
Splunk: The SIEM Leader Is A Great Buy On Declines