Splunk is Suddenly Looking Like a Slam Dunk

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The story on Splunk Inc. (NASDAQ: SPLK) isn’t an unfamiliar one.

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During the early months of the pandemic, the software stock soared to record highs on the accelerated digital transformation (not to mention stay-at-home trader euphoria). 

As normalization and Fed rate hikes then set in, the stock fell hard. The surprise departure of former CEO Doug Merritt added to the uncertainty. In the case of Splunk, a two-year freefall from $225 to $65 sunk the stock to its lowest level since 2017.

A happy ending may still be yet to come.

Last week’s third-quarter earnings report showed that the company’s data analytics offerings remain highly relevant in a faltering economy. Splunk’s December 1st high-volume gapper could turn out to be the spark that ignited 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 website analytics. Enterprises looking to gain a competitive edge use Splunk software to get their arms around big data sets and capitalize on opportunities or resolve issues. 

Splunk’s flagship Enterprise offering is a machine data platform that can gather 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 like Amazon S3 and Hadoop. It is 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 clients. More than 90 of the Fortune 100 companies have deployed Splunk software. Overseas, the company’s international success stories include Carrefour, Puma and Heineken.

Why Did Splunk Stock Go Up?

After the market close on November 30th, 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 enterprises are still investing in the Splunk platform but also that cost-cutting 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 recording a 21.3% adjusted operating margin in Q3, the company expects to achieve a 23% to 26% margin 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 improving margins have been a rare combination to come by in the tech sector lately.

Splunk extended the earnings rally by announcing an extended partnership with Amazon Web Services (AWS) the following day. The collaboration allows joint customers to migrate cloud computing environments and securely scale modernized workloads. Splunk and AWS, who have worked together for 10 years, committed to another five years. 

Joining forces 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 the gains in the next day’s down market.

What Makes Splunk Stock a Good Investment?

Where Splunk goes from here will largely hinge on the economic environment, but also the progression of emerging technologies like 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 in the intermediate term. The company’s core IT operations management platform is being complemented by network security and application performance management solutions that are creating new revenue streams.

A diversifying subscription model that generates recurring revenue is the main attraction to 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 omen for the longer-term trend as Splunk’s shift to cloud software continues.

Another shift Splunk is making is perpetual licenses to ratable licenses, a transition other software players have successfully done. Ratable licenses involve smaller upfront payments and are paid in smaller installments, but typically have a greater value over the life of the contract. This limits profitability in the short run but, like the shift to cloud offerings, should lead to stronger long-term earnings.

Splunk’s $20 surge since October makes it a less attractive takeover candidate as many have speculated it could be. But the better reason to like the stock is the demand for real-time business decision solutions tied to industrial automation and other disruptive technologies. The other side of the business model transformation should come with spunkier growth and profits.

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