Datawatch: Twenty Feet From Stardom

"What we lack is visibility in the market." - Michael Morrison, CEO Datawatch

If you go by equity appreciation, then the turnaround strategy at Datawatch (DWCH) has been a phenomenal success. The stock shot up from $12.40 to $38.70 in about six months beginning in May of 2013, but has come down to the $30 range in the last quarter. Much of this price propulsion can be attributed to two primary catalysts - the froth in the "big data" analytic sector which still exists today, and the acquisition of Panopticon back in June. At the time of the acquisition, Panopticon was the leading real-time Visual Discovery vendor, a direct competitor with Tableau Software (DATA).

Some Background

Datawatch was founded in 1985, and can boast a client base that includes 99 of the Fortune 100, and 495 of the S&P 500 companies. The company's "heritage" or "legacy" technology is best described by Alex Woodie of Datanami:

Prior to its acquisition of Panopticon, Datawatch's strength lay in the area of processing semi-structured and unstructured data. Its flagship Monarch offering gave customers the capability to ingest all types of data and documents--including reports in plain text or PDF formats--create a model based on the metadata contained in those reports, and yield more structured data as output.

That technology was suitable for 20th century analytics, but real-time visualization is becoming a business norm with the advent of on-the-fly data mining. Tableau Software, Splunk (SPLK) and Qlik Technologies (QLIK) have been market leaders the past few years. Enter Panopticon.

Panopticon: The Tail That Wags The Dog

Although the purchase of Panopticon could be considered a tuck-in acquisition (an all-stock transaction of approximately $31.4 million), it was a critical step in the transformation of Datawatch which began in 2011 when CEO Michael Morrison took over the helm. According to the company, this marriage created the only vendor in the analytics market that can access and transform any variety of data, and deliver data in real-time. It was no coincidence the stock heated up like a microwave oven after the merger was made public.

In addition to technology, Panopticon added 75 customers to Datawatch’s existing customer base, including Bank of America (BAC), Citigroup (C), Credit Suisse (CS), Amgen (AMGN), Novartis (NVS), Vodafone (VOD), and Shell (RDS-A). OEM relationships with SAP (SAP) and Thompson Reuters also ensued. Based on the new clients that were folded into the Datawatch family, you can see the company is highly levered to some vertical markets like the financials. Alliances with Qlik, Accenture (ACN), and Deloitte also came with the package.

Although Qlik can be seen as a competitor in some instances, both companies share a lot of the same customers. The Qlik product is used for very different purposes than what the Panopticon technology is utilized for. The same can be said for Splunk. Fast-forward five months to November of 2013, and Datawatch announced an alliance with Splunk. Like Qlik, Splunk offers some of the same services Datawatch does, especially in data mining. However, it's a separate set of circumstances for Tableau Software.

As expressed by the CEO at during the acquisition announcement:

I believe that this particular transaction will certainly bring Datawatch more in line with what you might see from a Tableau, in terms of applications and capabilities. So I would certainly see us on their radar, probably more frequently than you would have in the past.

Battle lines are being drawn in data visualization. Although Datawatch purportedly has the lead in technology, Tableau is a much larger rival with new iterations of its software scheduled to be released in the Q2 2014, and early 2015.

The "Land and Expand" Strategy

In the 2013 Q4 Conference Call, Chief Marketing Officer Ben Plummer discussed the company's "land and expand" strategy. Datawatch is attacking the market by focusing on its legacy customer base with a big emphasis on specialties they excel in. Most notably real-time data analytics. A big push into the Asia-Pacific region is also on the docket. There isn't as much competition in this geographic sector with Tableau, Qlik Tech, or Tibco's Spotfire (TIBX). However, Europe and the United States are still extremely important markets.

A recent partnership with IBM (IBM), may help Datawatch in the ever expanding data mining and analytic market globally. As explained by CEO Morrison:

We entered into an agreement with IBM, where IBM will resell our Datawatch solutions for report mining in analytics against documents stored in IBM Enterprise Content Management systems. While we have had an informal relationship with IBM for years, this is the first time that IBM has agreed to put our solution on their price list and resell it.

Although the big data visualization market is a drop in the bucket to a behemoth like IBM, it's a big deal for a smaller company like Datawatch. Additional boots on the ground with the pedigree of the Big Blue sales force can only be beneficial to the bottom line.

In the 2014 Q1 Conference Call, it was stated that customers initially landed include, HSBC (HSBC), Standard Chartered Bank (STAN.L), and Memorial Healthcare. Customers where the company expanded more significantly on initial purchases of its visual data discovery solution included Citigroup, Invesco (IVZ), and Deutsche Bank (DB). The alliance with IBM was well underway in Q1, but no specifics as to which accounts they participated in.

As a side note, this tack is not to be confused with Tableau's "land and expand" strategy. I don't know if there is a bit of copycatting going on here, but the implementation for both companies is quite different. Tableau Software's approach is to offer its product for free as a teaser, hook the individual customer with the plug-and-play attributes, then go after the department when word of mouth steamrolls the purchasing process.

Playing Catch-Up With Tableau Software

In the "big data" technology and services market, IDC projects a 27% compound annual growth rate to $32.4 billion through 2017. This is about six times the growth rate of the overall information and communications technology market. With Datawatch and Tableau Software the two primary pure-plays in data visualization, there is probably room for both companies. Nevertheless, even with the acquisition of Panopticon, Datawatch was late to the party although they've got a rock solid position in certain vertical markets like financials.

Here are some paraphrased statements by CEO Morrison in the most recent earnings presentation:

• I would characterize what we've done in Q4 and Q1 as primimg the pump.
• We've got a lot of work to do to get on the radar screen.
• The offering we have in visual data discovery is very much like Tableau.

Although the Datawatch visualization product may be very much like Tableau's, Tableau Software was founded over ten years ago at Stanford University, so they've got a big head start.

In 2010, Tableau's revenues were approximately $34 million. That's more than what Datawatch sold three years later in 2013 ($30.3 million in fiscal 2013, a 16% increase over the $26 million in sales for 2012). Last year, Tableau's revenues were $232.5 million, growth of 82% over 2012. Some of the Datawatch sales were derived from the data mining part of the business, so it's not an apples to apples comparison. Taking that into consideration, it makes the task of catching Tableau more daunting. Datawatch has a huge gap to overcome.

The Bottom Line

The documentary film Twenty Feet From Stardom focuses on the backup singers on some of the most prolific rock and roll songs back in the 60's and 70's. Although mega talented, the movie's subjects just never made it to the big time. I believe this may be the same fate for Datawatch. It will be successful, but as a niche player in data visualization with strengths in some vertical markets. With the advent of Twitter (TWTR) and other forms of social media, word of mouth spreads very quickly on an international basis where business, politics and pop culture are concerned. Tableau has too big of a jump on the smaller company.

In closing, for turnaround technology company, the stock is not grossly overvalued like its rival Tableau Software. According to the most recent statistics on Yahoo Finance, it has a market cap of $256.44 million (it should be noted the company issued a stock offering after the market cap figure was released, but it's in the ballpark). Price/Sales for the trailing twelve months is 7.94. Price/Book for the most recent quarter is 5.28. Although the turnaround strategy has been a success to this point, it doesn't guarantee it will continue to gain traction. My opinion is that the entire big data analytic sector is overvalued, and if there is sector rotation, or a market correction, this stock will fall like its peers.

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This concludes a three part series on big data mining and analytic pure plays. Previous postings focusing on Splunk and Tableau Software were utilized for statistics in this article.

Tableau Software: When You're Hot, You're Hot

"Big Data" visualization pure-play Tableau Software's (DATA) "land and expand" business model has paid of in spades. It's a grassroots level strategy that often nets individual customers via free trials, then spreads across an organization's departments, divisions and geographies via word-of-mouth. According to the most recent conference call, the overall average initial order size has consistently been under $10,000. That same document reported Tableau closing 179 transactions greater than $100,000 for the quarter.

It was a blowout quarter in a blowout year for the Seattle based company. Wall Street has taken notice, and propelled the shares to over $90 after coming public at $31 just nine months prior. Shares reached $100 in recent a market upswing, but have sold off 10% in the past few weeks. However, it still remains one of Wall Street's glamour stocks.

With 2014 revenues guidance at $320-$325 million, and a lofty market cap just north of five billion dollars, my contention is that the equity is way over its skis for long term investors. Ninety dollars a share is just not sustainable. Nevertheless, the market can stay irrational longer than you can stay solvent, or so the old chestnut goes, so short sellers beware. I believe there are some catalysts for short term traders that may push shares even higher because the data analytic sub-sector is in vogue at this juncture.

Catalyst #1: Gartner Positions Tableau as a Leader in Business Intelligence

For the second year running, Gartner selected Tableau as a leader in its Magic Quadrant for business intelligence and data analytic platforms.

(Chart Source: Gartner)

If you examine the chart closely, you can see Tableau outpacing competitors such as Microsoft (MSFT), Qlik Technologies (QLIK), Tibco Software (TIBX), Oracle (ORCL), and IBM (IBM). According to Gartner, "It is very likely that 2014 will be a critical year in which the task of making 'hard types of analysis easy' for an expanded set of users will continue to dominate Business Intelligence market requirements.". Tableau's easy-to-use, plug and play software makes it a hit for end-users as the company invents and commercializes cutting edge advances in analytics. You can see one reason why Wall Street put shares prices at a premium. Traders and investors both like technology leaders, and Tableau certainly fits the bill.

Catalyst #2: The Partnership with Splunk

Earlier this month, Tableau and Splunk (SPLK) announced a strategic technology alliance. Although both companies reside in the data intelligence sub-sector, they're more or less complimentary technologies. Splunk leads the market in enabling organizations to collect, index and make searchable unstructured data. Tableau Software's products allow you to visualize that data in the form of charts and graphs.

To give an example, it's almost like the 2002 movie Minority Report, where police officers can predict murders before they happen. Big banks of computers crunch numbers that will predict the probability of a murder - where and when it's going to happen. That's the analytic side of the equation, where Splunk fits in. The holograms the police use to massage and interpret the data is a function of what Tableau does. Like a souped up Excel spreadsheet.

Tableau's mission is to help people see and understand data. Coupled with Splunk's large pool of the flotsam and jetsam of the machine age, additional sales should be generated for both companies. More than 7,000 enterprises in 90 countries use Splunk software to deepen business and customer understanding. Combine that with the 17,000 client base of Tableau, and you've got a potent mixture. However, both equities have come a long way in a short period of time. Like Tableau, Splunk has more than doubled in value this past year.

Catalyst #3: The Blowout Quarter

The numbers were outstanding:

• Tableau posted a record fourth quarter delivering total revenue of $81.5 million. Wall Street consensus had been modeling for $67.1 million. This represented a 95% increase over the prior year Q4.
• For the full year, it posted total revenues of $232.5 million, growth of 82% over 2012.
• The company achieved a compound annual growth rate of 89% over the past three years.
• International sales were 22% of total revenues. CEO Christian Chabot believes that the international business operations are what the domestic side of the business was like three or four years ago. There is plenty of room for overseas expansion.

As CFO Tom Walker stated during the conference call: "In any given year, we generate the majority of our sales from customers previously acquired.". The land and expand strategy again. Google (GOOG), PepsiCo (PEP), Capital One (COF), Delta Airlines (DAL), Deutsche Telekom, Ford (F), and Bristol-Myers Squibb (BMY) are just some of the companies under the Tableau umbrella. Compound this with the partnership with Splunk, and you've got a real growth story on your hands.

Going Forward

According to management, two things in regards to prospective enterprise clients happened last year that helped contribute to the dramatic increase in sales. One was the success of the IPO which introduced Tableau to a larger base of customers. The second is the release of Tableau 8.1 in November. This provided users with more advanced analytic capabilities by integrating with the open source statistics program R. Tableau is scheduled to release version 8.2 in the second quarter, and Tableau version 9 in the first half of 2015. These releases could also be catalysts for increased sales.

Here's where it gets dicey. Although quarter-to-quarter can be lumpy (Q1 is notoriously know for being light), the company has projected annual revenue growth of approximately 40% at the high end for 2014. That's a far cry from the 82% in 2013. Granted, the company can't grow at almost 90% forever, and this 40% projection could be a low ball figure, but that's a significant drop. As far as earnings go, there are none for 2014. The company is expecting non-GAAP operating losses of between $15 and $20 million for next year. This is because the company is investing heavily in R&D, and increasing headcount. In addition, management expects gross margins to decrease because of the additional expenditures.

Conclusion

This is a pricey stock. Yahoo Finance valuation statistics show:

• Price/Sales (trailing twelve months) of 23.34.
• Price/Book (most recent quarter) of 22.18.
• Total Cash Per Share (most recent quarter) is $4.15.
• Enterprise Value/Revenue (trailing twelve months) is 22.70.
• Short % of Float (as of March 11th, 2014) is 3.7%, as reported by The Wall Street Journal.

It should be noted that the short float decreased by almost 10% right after the earnings release because a short squeeze ensued. This stock is in play, but you're paying top dollar for it.

If you like to trade based on momentum, this could be a stock for you. It sits in the intersection of two red hot sectors, big data analytic pure plays and recent IPO's. That said, if you're like me and prefer growth at a reasonable price, better buying opportunities may be on the horizon. For instance, the company will be issuing additional shares of stock, which may put pressure on the inflated price. Macro headwinds are always in the picture, too.

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Sections of this article were aided by Tableau Software's recently released 10-K (.pdf file). It is the second in a series of "big data" mining and analytic pure plays posts. The first one featuring Splunk can be found here.

Splunk: Expensive By Most Metrics

Mining and analyzing unstructured machine data is a business practice that's here to stay. Last year was a huge year for many small cap "Big Data" stocks. Splunk (SPLK), Tableau Software (DATA), and Datawatch (DWCH) doubled, and even tripled in value. Much larger competitors in the business intelligence arena didn't fare so well. EMC (EMC), IBM (IBM), Oracle (ORCL), and SAP (SAP) had lackluster performances in a year that the S&P 500 was up nearly 30%. That said, the smaller data analytic securities appear to be overvalued, most notably Splunk.

The Company

Splunk is the undisputed leader in operational intelligence of the data analytic pure plays. Its software detects gridlock in a corporation's networks, and can massage data in innovative ways to improve organizational performance. CEO Godfrey Sullivan talks about two examples in the most recent conference call:

One of our large customers is analyzing the position and performance of fuel tankers on some of the world's most dangerous roads, proactively monitoring for speeding, illegal fuel transfers, breakdowns and hijackings. Additionally, a large U.S. government contractor is using us to analyze its sensor data from industrial facilities to prevent dangerous accidents in handling hazardous materials.

To paraphrase the most recent 10-K, the core of Splunk's software is a proprietary machine data engine that enables dynamic schema creation on the fly. End users can run queries without having to understand the structure of the data. Splunk compliments the core product with additional content in the form of apps or add-ons that can be deployed on top of the main data engine. It doesn't require customization, long deployment cycles or extensive professional services commonly associated with traditional enterprise software applications. It works like a browser, much like Google's (GOOG) Chrome.

Last quarter, Splunk added 500 new customers, upping the total to 7,000 worldwide. This includes roughly 60 of the Fortune 100. Although this is a significant penetration of the upper echelon in business, the statistic is somewhat misleading. Those 60 companies don't encompass the entire organization, but may represent just a department or two for each specific entity. Nevertheless, Splunk is making inroads with its disruptive technology.

If this is just the dawn of the machine data revolution, there is plenty of room for growth. For instance, the company's year-over-year quarterly revenue has grown by over 50% in each of the past four quarters, as reported by Investor's Business Daily. Although this growth may not be sustainable, it may still continue at an above average rate, at least compared to the competition like an IBM.

In reading the prepared remarks in the conference call, you come away impressed by the new and upcoming revenue streams created by Splunk partnerships. These relationships include:

• A recently launched joint go-to-market initiative with Cisco (CSCO), focused on simplifying and accelerating threat visibility with the Cisco Identity Services Engine.
• Conducting an upcoming 20 city road show with Palo Alto Networks (PANW), one of Splunk's top security channel partners.
• Because of Hunk, which is the Splunk analytic for Hadoop, the company has established partnerships with privately held Hortonworks, Cloudera, and MapR.
• A partnership with Amazon (AMZN), where Hunk will be offered on the Amazon Web Services marketplace.
• Post earnings release, there was also a partnership announced with Tableau Software. The combination of the Splunk and Tableau services have limited overlap because the technologies compliment each other.

In order to stay ahead of the technology curve, Splunk spends a considerable amount of money on R&D, $41.9 million in fiscal 2013, almost double the $23.6 million spent in 2012. Although fiscal 2014 R&D expenditures won't be released until early April, Splunk has a history of pouring money back into the company for future business development. In addition, what it can't create in-house, it goes out and gets. BugSense was bought in Q3 to enable direct access to data from mobile devices into Splunk. In Q4, the company purchased Cloudmeter so clients can capture data directly from their networks.

Valuation

Splunk had a tremendous Q4 reporting revenue of $99.9 million. Full year fiscal 2014 sales were $302 million, up 52% year-over-year. Although earnings per share for the quarter equaled $0.03, its full year non-GAAP net loss was $3.1 million, or $0.03 loss per share based on a share count of 105 million. The company will probably continue to incur losses, or, break even as it plows more money into R&D, acquisitions, and expanding headcount. For example, employees grew by 300 for the full year, making the total 1,000 under the Splunk umbrella.

For fiscal 2015 (the current calendar year), the company provided guidance of $400 million in revenue. In Q1, sales projections are for $78-$80 million, with an operating margin of minus 8%-10%. I believe that it can be safely stated that a young public company like Splunk should not be valued on an EPS basis because it's investing considerable amounts for growth. It probably won't be profitable for awhile, and if it does get into the black, net profits will be negligible. However, Price/Sales can be utilized as a barometer as to how expensive the equity is.

Utilizing Yahoo Finance statistics, we can observe that the Price/Sales for the trailing twelve months is 32. That's extremely expensive for a company that is guiding revenue growth of roughly 33% for the full fiscal year. Price/Book for the most recent quarter is 12.6. Another generous metric. The market cap is a whopping 9.8 billion. The short float as of February 14th is 3.1%, which may have trended lower since the stock has pulled back significantly the last week. Its intraday high was $106 on February 28th, but has sold off this past week to $88. Quite a drop if you were riding the momentum.

Conclusion

My personal preference in investing is growth at a reasonable price. At this juncture, Splunk doesn't fit the bill, although you may make money with the stock going forward. Consensus opinion calls for a $105 price for Splunk during the next twelve months. Many analysts believe it's a "market perform", which means it will trade in conjunction with the overall indexes. The high price estimate is for $122, the low comes in at $78. Depending on who you follow, you can probably still make a profit with Splunk, but the easy money has been made. It rallied from $28 to it's current price of $88 in 15 months.

It is of my opinion that the overall indexes are backing and filling right now, and could continue to move sideways for the next quarter. In addition, some market pockets such as biotechnology, 2013 IPO's, and the data mining pure plays have made huge runs, and could be ripe for a sector rotation. Geopolitical issues are always a headwind, especially with the Russian invasion of Crimea we are currently experiencing. Combine those opinions with the fact Splunk's revenue growth may be slowing based on the overall expansion of the company, you've got yourself a perfect storm for obtaining shares at a reduced rate.