Splunk Inc (SPLK, Financial) has been a company to watch out for in 2020 as the macro tailwinds coupled with the management's investments in its cloud offerings and observability solutions have propelled the stock to a new 52-week high.
The company's annual recurring revenue continues to grow at a solid pace, and it also showed an improvement in its contract durations. There have been some key management changes as Splunk delivered a decent quarterly result and had an optimistic outlook for 2020. This prompted a number of equity research analysts to upgrade the company's rating and led to increased buying and a jump in the stock price. Splunk's transition into a cloud-first subscription-based market leader makes the stock an interesting pick, in my opinion.
Increasing recurring revenues and improved contract durations
After the $1.05 billion SignalFX acquisition in 2019, Splunk has become a leading player in the cloud space, particularly in the cloud monitoring solutions. The company's annual recurring revenues (ARR) have increased to $1.962 billion in the most recent quarter with the cloud solutions contributing as much as 26% to the same.
Cloud ARR is around $568 million as per the recent quarterly result and the cloud solutions have accounted for about 53% of the total software bookings of Splunk. The 26% contribution to the top-line has been consistent with the first quarter of 2020 and has doubled from the 2019 numbers. This quarter-over-quarter increase in cloud revenues has been consistent despite the company's overall quarterly results depicting a sense of seasonality (e.g.: after a strong Q4, the company usually has a weak Q1 in terms of revenues, but this does not apply to the cloud, which is constantly growing). This is a part of the company's process of transitioning from the total contract value-based revenue model to a subscription-based revenue model.
Interestingly, the company's average contract duration for cloud solutions had witnessed a significant drop from 33.6 months in 2019 to 27.4 months in the first quarter, which I think is likely due to the uncertainty caused by the pandemic. However, this has shown a strong sign of recovery and has increased to 30.3 months as of the recent quarter, which is again a very positive sign.
Mediocre result but a positive outlook
Splunk's result for the second quarter was mediocre as it managed to deliver a non-GAAP earnings beat but missed the analyst consensus estimates on the revenue front and the GAAP earnings front.
The company delivered a top-line of $491.6 million, which was lower than the corresponding quarter of the previous year by about 4.8% and missed the analyst consensus estimates by $28.68 million. While the company witnessed a phenomenal growth in the Annual Recurring Revenues (ARRs), especially the cloud revenues which rose by a staggering 79% to $126 million, the overall top-line did fall largely due to the to the subscription model and its focus on becoming a cloud-first solutions provider.
In terms of earnings, the company posted a non-GAAP loss per share of 33 cents, which was 1 cent better than the analyst estimates. However, it reported a GAAP loss per share of $1.64, which was 22 cents worse as compared to the analyst consensus.
The mediocre result sent the stock down at the time, but it has recovered over the past few weeks after a series of analyst upgrades.
Among the upgrading research houses were Evercore and Bair,d which raised the company's rating from "Neutral"/ "In-Line" to "Outperform" and attributed it to the growth in subscriptions and the cloud business.
The Splunk management is optimistic about the next quarter and expects revenue between $600 million and $630 million with a positive non-GAAP operating margin between 2% and 5%.
Key management changes
Splunk has made some key changes in senior management and has elevated three senior customer-facing executives to assist CEO Doug Merritt in the company's future phases of growth and category leadership.
Among the new names are John Sabino, the company's ex-senior vice president of Customer Success since 2017, who has now been promoted to Chief Customer Officer. It is worth highlighting that Sabino is a highly experienced professional and has many years of experience in cloud business transformation, customer success, digital strategy, sales and Internet of Things at companies like General Electric (GE, Financial) and NBC Universal.
The second key name in the new senior management is Christian Smith, the ex-senior Vice President of Global Sales who has been made the Chief Revenue Officer. Smith has over 25 years of experience in cloud, SaaS (software-as-a-service) sales and marketing, scaling sales organizations and acquisition integration with brands like Oracle (ORCL, Financial), APG and Daptiv. He played a key role in the SignalFX integration after the company's acquisition by Splunk in 2019.
The third name is Carrie Palin, the new Chief Marketing Officer of Splunk, a marketing veteran with over two decades of experience in the Silicon Valley.
Final thoughts
There is little doubt in my mind that Splunk has demonstrated excellent growth, but its stock is not cheap by any standards. The company is trading at a price-sales ratio of 13.71 and a price-book ratio as high as 19.61. Both these valuation multiples are significantly above the software industry averages. The premium on the trading multiples, coupled with a high beta of 1.58, makes the company's stock risky and susceptible to a significant fall, especially if the management does not deliver on its thrid quarter guidance.
It is also worth highlighting that Splunk competes with giants like Amazon (AMZN, Financial), Microsoft (MSFT, Financial) and IBM (IBM, Financial), so an investment in the stock is not free from competitive risks. Overall, I think Splunk does appear to be a decent stock to hold on to, and it is also worth adding to one's watch list, but it definitely appears expensive at current levels.
Disclosure: No positions.
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