Sunday, September 6, 2015

Splunk: In No Man's Land

"Big Data is a broad term for data sets so large or complex that traditional data processing applications are inadequate." - From Wikipedia.

If you're in the corporate world, the concept of Big Data is nothing new. Even Main Street is aware of phenomenon, if not by name, then by practice. One example is Sabermetrics, the advanced baseball analytics made popular by the book Moneyball by Michael Lewis, and made even more popular by the movie of the same name starring Brad Pitt. Another is Amazon (AMZN) recommendations. The more you shop, the more they know about you. That's Big Data at work.

Although this mining and massaging of data is here to stay, Big Data as we know it is morphing from static sources to continuous data streams of spontaneous creation. This actionable data is created by HVAC controllers, smart electrical meters, GPS devices, RFID tags, smartphones and electronic wearables like a FitBit. We are now entering into the era of telemetry, the automated communications process by which measurements are made, and other data collected at remote points, then transmitted to receiving equipment for monitoring. This is where Splunk (SPLK) comes into play.

I did a posting about Splunk in early 2014 when it was the flavor of the month along with its entire sector of data mining and analytics securities. For a more detailed look into Splunk's business model, you can find my previous article here. At the time, I thought the equity was overvalued, and still do by a price/sales metric, but valuations have come down significantly in a year and a half.

Source: Stock Charts

If you examine the above chart, you can see where the stock was extremely overvalued. Stair step pattern on the way up. Elevator on the way down - penthouse to lobby in a matter of a month. However, if you are a long-term investor and bought at the IPO price of about $25 three yeas ago, you doubled your money. That beats the market. I don't want to go over old material from my last posting about Splunk, so I will concentrate on two areas of interest the company has been expanding the past 18 months, Security and Cloud.

Security

Every digital action produces actionable data, and Splunk's predictive analytics puts them at the forefront of Internet security for both corporations and The United States Government. According to CFO David Conte in the most recent conference call:

Security two plus years ago was 20% to 25% of business, and the end of last year, it ended up being not quite 50%, but over 40%.

With so much of the company's revenues devoted to security, I was surprised it didn't get caught in the updraft during the past year of many cyber security equities like partner Palo Alto Networks (PANW), which has had an incredible run, and to a lesser degree the PureFunds ISE Cyber Security ETF (HACK). That hasn't been the case. Perhaps investor sentiment will change once the market gets back in gear because of two recent acquisitions.

The first acquisition is Metafor Software, an anomaly detection and machine learning company. Splunk plans to fold in Metafor's technology into their already existing platform. The second purchase is Caspida, which adds Behavioral Analytics and machine learning to better detect advanced threats and malicious insider penetration. The software uncovers hidden breaches and new attacks out-of-the-box without extensive customization. Splunk will offer this product as a standalone application and bundle it in with their existing product line.

In the last conference call, company chief Godfrey Sullivan commented that security has become the main conduit to gain access into the inner workings of IT departments. For the first time security is serving as a steward for a lot of machine data across an organization. Splunk's sales department now targets security departments of potential clients, then expands across to application development or IT operations. Four years ago, it was the other way around, you'd go through IT operations to get to security. Splunk is the nerve center of security as one executive stated.

Cloud

Another initiative Splunk has recently launched to increase its Total Addressable Market [TAM] is its cloud service. Splunk cloud is now available through nine Amazon Web Services global regions. The results from the international launch look promising, and in the past nine months, clients have tripled their orders. According to a Splunk executive:

Our customers are excited with the speed and ease of Splunk cloud. They are happy to focus their time and attention on analyzing data to achieve their business results rather than procuring and deploying equipment.

Company management also believes they have the only solution in the marketplace that gives clients a true hybrid experience. They can search seamlessly across data stored on premises and in the cloud to get a unified experience with a single Splunk interface. One example is The City of Los Angeles who purchased Splunk cloud and the application for enterprise security to correlate cyber threat information with several other governments. This solution allows Los Angeles to monitor and analyze network traffic to identify discrepancies that indicate malicious attacks.

Offering a cloud or software-as-a-service solution is the way that many enterprise software companies are transitioning. It enables you to reach smaller customers with an out-of-the-box solution, plus takes away implementation headaches for IT departments in larger organizations. However, corporations like Adobe (ADBE) and Nuance (NUAN) made the switch, and found that it put pressure on equity valuations for a number of years. Although Splunk is in the early stages with its cloud offering, it's something potential investors should be aware of.

Some Statistics

Some pertinent points addressed in the conference call:

  • Revenues were up 46% over the past year.
  • The company can claim 10,000 customers worldwide. Including 79 of the Fortune 100 companies.
  • Since they denominate revenue globally in U.S. dollars, they do not have foreign exchange exposure.
  • Splunk expects to be profitable on a non-GAAP basis for the balance of the year.

Valuation

When I wrote my initial post about Splunk, trailing twelve month price/sales was 32 with a market cap of 9.8 billion dollars. Now it's much more reasonable with a price/sales of 14 and a market cap of 7.56 billion dollars. Still expensive. This can be reflected by the short float of roughly 11% as of two weeks ago. In addition, after a well executed quarter as reported on August 27th, the stock price went down. I realize there is no cookie cutter answer as to when the current overall stock market correction will be over, but it's taking all the growth with no earnings equities down, Splunk included.

Splunk excels at telemetric data collection with machine-to-machine data mining and analytics. This sounds like science fiction and that's why I like the company. They're using 21st Century technology in a 21st Century world. If you are considering investing in Splunk in anticipation of it regaining its go-go days of two years ago, I believe you will be disappointed. However, if you want a high growth company that appears to be turning profitable, this may be the right stock for you if you temper your expectations on price performance.

Liking a company and liking a stock price are two separate situations. I am not alone in my conclusion. A Barron's assessment of the conference call echoes my beliefs, or perhaps I'm parroting Wall Street consensus. As far as equities go, Splunk reminds me a lot of Acme Packet, a security that was engulfed by Oracle (ORCL) many years ago. Both pure-play companies had big runs, then crashed, although their respective technologies were deemed superior. I don't know what's in store for Splunk, but they'll probably be around for a long time unless a company like IBM has a better idea.