I said recently in my earnings season wrap up (http://discussion.fool.com/bear39s-earnings-season-wrap-up-32817…) that Splunk had a solid quarter. I stand by that. Revenue growth ticked up from 30% to 32%, and though Maintenance and services revenue only grew 41% vs 48% last quarter, that’s still solid growth for the recurring stuff.
I don’t see any problems for Splunk. I still think SPLK shares are safe money. The reason I’m selling is opportunity cost. Let me explain a bit about what got me thinking that other opportunities afford more upside potential than Splunk.
When I got excited about Splunk back in January, a lot of it had to do with their Jan 12 Investor Presentation. I wrote about it here: http://discussion.fool.com/splunk-32565994.aspx One of my key takeaways was:
- Three years from now operating margin will be 12-14% (it’s 6% now). After that, they expect cloud to hit an inflection point, where margins will really start to increase in a “non-linear” way.
Unfortunately, I didn’t yet quite understand how the SBC picture plays into this. Let me try to break it down. Over the last 12 months, they’ve given $380M in SBC. Compared to just under $1.1B TTM revenue, SBC is about 35% of revenue. Splunk’s profit margin (non-GAAP) is 6%. That means all 6%, and another 29%, is SBC.
Now let’s say they hold SBC at $380M for 3 years, not increasing it at all through 2020, when annual revenue is supposed to be $2.3B. SBC would still be 17% of revenue. So the 12-14% they say will be their profit margin is still all because of SBC. This means on a GAAP basis, they’ll still be unprofitable. This isn’t new. They said this in the Investor Presentation. It’s also not the end of the world. It just didn’t hit me until now. I guess when in the July quarter they spent almost 10% more on S&M than last quarter (27% more YoY) I realized: the spending is gonna keep increasing for a long time. It SEEMS like they could simply hold opex spending for a few quarters (like Hortonworks has been doing) and get to GAAP breakeven within a year or so. How much would that REALLY hold them back? I mean they’re spending tens of millions more than last year, but still only getting about 500 new customers per quarter. Where’s the money going?
Again, I’m not alarmed. Demand isn’t cratering. There’s nothing really wrong. And in reality I have no idea if Splunk could really be spending less or if that’s a terrible idea. What do I know about what they actually need to run the company and keep growing, etc? They’re basically doing what they said they’d do, with slight beats and raises to keep up with the Joneses. My guess is they’ll be fine, but it will be slow and steady. Maybe Splunk will actually end up closer to 3B in 2020 revenue instead of 2.3B. If their PS is still 8 or 9, market cap would be 3 times what they’re worth today. Even with dilution, shares could be near $150. I don’t think anyone would complain about that outcome, and I believe it could happen.
But I don’t see it doubling in a year. It may sound ridiculous to point to that as any kind of barometer, but as I said, this game is about opportunity cost. Wix could absolutely double in a year. SHOP, of course! HUBS, SQ, TWLO. Yes. I’m trying to max out the potential in my portfolio. It’s aggressive, it may not be for everyone, and I’ll 100% for sure miss out on some very very good growers that I just wasn’t excited enough about. But that is why I sold Splunk today, and I just thought I’d explain in case some folks are interested.
PS - In other words, Andy nailed it: http://discussion.fool.com/the-valuation-bit-might-also-interest…