Splunk Delivers A Blowout Quarter, We Maintain Accumulate Rating

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On The Way To Becoming A Business School Case Study

If you really have nothing better to do, read up on our prior notes on Splunk Inc. (NASDAQ:SPLK), dating back to when the company was in difficulties. Start by reading the stuff we posted on the free side of Seeking Alpha a hundred years ago. You can find that here.

Read the oldest article first, where we are very critical of SPLK's failure to keep up with the shift from perpetual licensing to subscription in the enterprise software world. And watch how our view changes as the company gets ahold of the problem over time.

Over and above those notes, we've covered the stock extensively and in real time in our Growth Investor Pro subscription service here on Seeking Alpha, where our fundamental and technical analysis is enriched and added to by one of our community members, who has a professional background in technology company turnarounds.

Now, recently the company fired its old CEO and CFO and replaced them with new, hard-charging blood. The new CEO, Gary Steele, was formerly CEO at Proofpoint, a cybersecurity company which enjoyed success as a public company before being sold to the buyout firm Thoma Bravo. The choice of such a background is not, we suspect, a coincidence. The Splunk shareholder register includes two Thoma Bravo peers, being Silver Lake and Hellman & Friedman, and the financials are setting the company up perfectly to be acquired by a buyout shop or shops. The company is, as we have said many times, an M&A target sat right there in plain sight.

The company just reported a killer quarter. We see the adverse stock reaction as an opportunity to consider adding to existing positions if you've been looking for a moment to do so, or to open a new position if you're minded to do so. You doubt us? Check the numbers below.

Let's draw out a few Q4 highlights:

• Revenue growth came in at +39% which is not only a huge rate of growth vs. the majority of software companies' fourth-quarter numbers, it's barely down on Q3 - whereas most other software names have seen material declines in growth rates.
• TTM revenue growth moved up to +37% vs the same quarter a year ago. This is not at all the norm in software right now where by and large companies are showing decelerating rates of growth.
• Gross margin is up to 78%, a level not achieved since the July 2020 quarter.
• EBITDA margins stand at 18% on a TTM basis and the margin progression is a thing of beauty - look at peak margins of +18% in the October 2019 quarter which then dip down into the negative as the transition from upfront licenses to subscription takes hold, then stepwise up every single quarter since the trough of -12% in the October 2021 quarter. If like us you have no outside interests and just like studying this kind of thing? That's a work of art right there.
• The same is true of unlevered pretax free cashflow (= EBITDA minus capex minus change in net working capital) which was at negative 21% on a TTM basis in the July 2020 quarter and is now up to positive 9% on a TTM basis.
• Balance sheet stands at net debt of $1.8bn which means leverage of 2.8x TTM EBITDA - that looks a lot for a public company but it's negligible for a leveraged buyout, and since this is an LBO-by-stealth, hiding in plain view on the public markets, that's just fine.
• Deferred revenue growth could be better at 19% up vs prior year - the company has some work to do in winning new prepaid orders, which is likely the source of Wall Street's ire on this name at present.

Valuation is unchallenging in our view.

And finally the stock chart. You can open a full page version, here.

We rate Splunk Inc. at Accumulate. Either no buyout takes place but the stock should move up by sheer force of that growth rate and the uptick in margins - or Splunk Inc. is in fact sold, in which case a one-time pop is likely to come shareholders' way.

Cestrian Capital Research, Inc - 2 March 2023.

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