The story on Splunk Inc. (NASDAQ: SPLK ) is not unknown.
During the first months of the pandemic, software stocks soared to record highs on the accelerated digital transformation (not to mention euphoria for home users).
As normalization and Fed interest rate hikes loomed, the stock fell hard. The surprise departure of former CEO Doug Merritt added to the uncertainty. As for Splunk, a two-year freefall from $225 to $65 sent the stock to its lowest level since 2017.
A happy ending may still be out there.
Last week’s earnings report for the third quarter showed that the company’s data analysis offering is still very relevant in a faltering economy. Splunk’s high-volume gap from December 1 could prove to be the spark that sparked a turnaround.
What does Splunk do?
Splunk’s data analytics software helps customers make more informed business decisions. It provides a real-time look at IT infrastructure, operations, security, compliance and a wide range of business and site analytics. Businesses looking to gain a competitive edge use Splunk software to get their arms around large data sets and exploit opportunities or solve problems.
Splunk’s flagship Enterprise offering is a machine computing platform that can collect and index massive amounts of data on a daily basis. Users can interact with Enterprise to analyze and visualize information stored in popular data sources such as Amazon S3 and Hadoop. It’s a market that has no shortage of competitors, including heavyweights like IBM, Intel and Microsoft.
Despite the competition, Splunk has managed to amass a growing set of customers. More than 90 of the Fortune 100 companies have deployed Splunk software. Abroad, the company’s international success stories include Carrefour, Puma and Heineken.
Why did Splunk stock go up?
After the market closed on Nov. 30, Splunk reported third-quarter revenue and earnings that crushed Wall Street expectations. Top-line growth was 40% and adjusted earnings of $0.83 were more than three times the consensus estimate. The results showed not only that companies are still investing in the Splunk platform, but also that cost-saving measures are taking hold.
This prompted management to raise its full-year outlook for revenue and profitability, giving investors more reason to bid up the stock. After posting an adjusted operating margin of 21.3% in Q3, the company expects to achieve a margin of 23% to 26% in the current quarter and a much higher full-year margin than previously expected. Forecasts for full-year revenue and free cash flow were also raised. Healthy revenue growth and better margins have been a rare combination in the tech sector lately.
Splunk extended its earnings rally by announcing an expanded partnership with Amazon Web Services (AWS) the next day. The collaboration allows joint customers to migrate cloud computing environments and securely scale modernized workloads. Splunk and AWS, which have worked together for 10 years, committed to another five years.
Teaming up with Amazon is never a bad idea. Combined with the beat and raise quarter, Splunk jumped 18% on December 1st and managed to hold most of its gains in the next day’s bear market.
What makes Splunk Stock a good investment?
Where Splunk goes from here will largely depend on the economic environment, but also the development of new technologies such as Internet-of-Things (IoT) and artificial intelligence (AI). As the industrial revolution unfolds, Splunk’s ability to help businesses identify and correct production and other operational issues should also be a long-term growth driver. These two opportunities are reasons to own the stock for the next five to ten years.
As these catalysts develop, Splunk’s presence in the fast-growing data analytics software space is expected to drive growth over the medium term. The company’s core IT operations platform is complemented by network security and application performance management solutions that create new revenue streams.
A diversifying subscription model that generates recurring revenue is the main attraction of software stocks, and Splunk certainly fits the mold. Although overall annual recurring revenue (ARR) growth has slowed, cloud-based ARR is growing at a higher clip—a good sign of the long-term trend as Splunk’s shift to cloud software continues.
Another shift that Splunk is making is perpetual licenses to rateable licenses, a transition other software players have made. Estimable licenses involve smaller upfront payments and are paid in smaller installments, but usually have a greater value over the life of the contract. This limits profitability in the short term, but should, like the transition to cloud services, lead to stronger long-term earnings.
Splunk’s $20 rise since October makes it a less attractive takeover candidate than many have speculated. But the best reason to like the stock is the demand for real-time business decision solutions related to industrial automation and other disruptive technologies. The other side of the business model transformation should come with greater growth and profits.