Stalking Splunk’s sales force – As Splunk’s full-year revenue guidance has historically been materially different from results, we decided to track approximately 800 of Splunk’s quota carrying sales force, including estimated quotas from current and potential future sales managers as per job postings.
Sales force quotas are key to forecasting accurate free cash flow – Estimating revenue per quota carrying sales person is key to determining future billings, operating leverage and free cash flow growth. The stock price primarily follows a trailing 12-month free cash flow yield. Using this metric makes sense to us as it does not punish Splunk or other Big Data companies transitioning from having a majority of product sales come from a perpetual license model to mostly subscription based over the next few years. The 4.5% dilution in shares over the past 12 months from stock-based compensation is in-line with peers.
SaaS Valuation remains a long way away – While Splunk’s growing subscription and maintenance / services mix (i.e. recurring revenue) have increased to around 50% of bookings, as a stand-alone business, its value is not an accurate representation of Splunk’s current valuation. Assuming an account churn rate similar to New Relic at about 50%, it is a valuation metric that likely won’t apply to Splunk for at least another four years by our estimate. Annual churn for subscription revenue would need to be about 10% for SaaS valuations to come into play. Increased disclosures of a lowered subscriber churn rate, higher subscriber revenue, and cost breakouts, are factors that we believe could lead to further upside in Splunk’s valuation and share price.
We are initiating coverage with a six-month target price of $93. Our target is based on a fiscal Q1 2019 trailing 12-month free cash flow yield of 2%. Over the last year and a half, Splunk’s market cap has yielded about 2% free cash flow. This 2% free cash flow yield is generally where other Big Data perpetual license companies trade at.
Biggest risks – In our view the biggest short-term risks are
- Any comments about softer enterprise spending will move the stock lower
- An increasing subscription mix versus perpetual licenses is a headwind to revenue.
- Comments about sales productivity coming lower will also cause us to re-evaluate our target
- If large customers begin reducing their Splunk usage due to its relatively high price
- Working capital issues that include A/R where customers pay off their accounts between January and April.
Exhibit 1: SPLK vs. the NASDAQ Composite
Source: Perspectec
SPLK primarily trades on a free cash flow basis – Looking at how the stock has traded historically on a trailing 12-month basis, both a 120x adjusted P/E valuation and 2% free cash flow yields (yield of its market capitalization) have come into play. A 120x adjusted P/E is not a sustainable valuation metric to use moving forward. Most importantly, the expected subscription increase mix will cause free cash flow to rise faster than revenue.
In the graph below, the current period target is based on $273 million in free cash flow over the 12 reported months ending in April 30th. Splunk’s current fair value is $65 per share. However, we believe the market is anticipating their fiscal year Q4’18 results, where we see the fair value moving up to $87 per share. Our methodology translates to a fair value target of $93 after reporting fiscal Q1 results sometime in late May.
Exhibit 2: SPLK vs. Other Valuation Methods
Source: Perspectec
The FCF analysis does not account for Splunk’s customer loyalty – One objection that could be used by investors is that free cash flow yield does not take into account the loyalty of a company’s customer base. Most public North American SaaS companies trade on an EV/EBITDA basis, with Customer Lifetime Value (CLTV) / Customer Growth Cost (CGC) being the basis for the EV/EBITDA multiple used. While Splunk does not provide churn for its subscribers (typically billed monthly), we see New Relic as a somewhat comparable big data analytics company, with pricing based on usage but whose revenues are entirely based on cloud subscriptions. New Relic’s customer churn for its monthly plans was roughly 50% (installed base duration) at the end of 2016. Using this as a proxy, we can estimate a rough valuation for Splunk for both its Maintenance/Services and Subscription recurring revenue businesses.
Allocating 100% of the company’s R&D and S&M costs between these two divisions for this analysis, the value of Splunk on a SaaS metrics basis falls short of a $0 value. Again, a SaaS valuation is a long way away from Splunk.
Exhibit 3: SPLK vs. SaaS Valuation
Source: Perspectec
We have tracked the large majority of Splunk’s quota-carrying sales force – Splunk provides annual guidance, and in November with their fiscal Q3 2018, they provided full-year fiscal 2019 (year ending January 2019) revenue and EBIT guidance. History has shown that after posting their initial full-year guidance, full-year results have beaten the initial guide by at least 12% and is on pace to beat fiscal 2018 by 7%. In order to come up with a more accurate way to forecast revenue and operating leverage of their quota-carrying sales people, we decided to estimate sales quotas of roughly 800 sales staff at Splunk and their associated costs.
Our conservative forecasts assume no increase in sales quotas for an individual sales person. Exhibits 4 and 5 show the Y/Y percentage increase in sales for an average quota carrying sales person for both the U.S. and Internationally, for both historically as well as our forecasts. We allocate quotas to be 10%, 30%, 60% and 100% of their expected full quota for the first four quarters when an individual starts, Within a quarter, allocated sales are time-weighted. For example, a U.S. sales manager starting January 15th for the quarter ending January 31st will have an estimated 16 / 92 x 10% of an established U.S. sales manager’s quota allocated to them. Our discussions with management and other sources lead us to believe this is a reasonable method to estimate sales.
Exhibit 4: Change and forecasted change in Splunk U.S. sales per quota-carrying sales person
Source: Perspectec
Exhibit 5: Change and forecasted change in Splunk International sales per quota carrying sales person
Source: Perspectec
Revenue per Direct Sales Manager in the U.S. increased at 11% Y/Y in fiscal Q3/18 vs. 32% Y/Y growth for total U.S. sales. In other words, we believe that 21% of the company’s Y/Y sales growth can be explained by the growth in the sales force. Beyond fiscal Q4/18, our forecasts assume a ZERO increase in Revenue per Direct Sales Manager. Our entire revenue growth assumptions are based on quota carrying sales person increases.
We conclude that fiscal 2019 guidance is based on the current sales force, growth in the size of Splunk’s sales force from current job postings, and flatlining sales quotas on a Y/Y basis. We believe that fiscal 2020 billings guidance of $2.3 billion and revenue guidance of $2 billion can be easily met, and operating leverage can occur as newer sales managers ramp up sales quotas.
Exhibit 6: Estimate for Splunk’s quota carrying sales force
Source: Perspectec
What does Splunk do again?
Splunk is a single software platform that allows users to monitor and analyze machine data from virtually any data source.
Some examples of machine log data and their sources are included in the exhibit below.
Exhibit 7: Examples of Data Splunk can collect
Source: Splunk
Splunk can:
- Collect (for Service Level Agreements)
- Store
- Ship (backup)
- Visualize (aided by Tableau type software)
- Search
- Analyze – (can anticipate future data)
- Report
Real-life Examples:
Ferguson Plumbing & Heating – Using Splunk cloud taking broad customer data and allowed them to segment customers by behaviour. Reporting was reduced from one month using Excel to real-time.
Dubai Airports – Splunk was used to analyze sensor data to drive efficiencies and improve the passenger experience. This included monitoring security stations to ensure less than 5 minute wait times for passengers, analyze data from the baggage system to deliver bags on time; monitor the Wi-Fi network to remove rogue hotspots and guarantee high-speed access, keeping bathrooms clean with alerts on bathroom sensors.
Domino’s Pizza – Used Splunk’s software to support its entire e-commerce environment. This included visualizing business sales trends such as orders per minute, number of transactions per store, what type of device was used to place an order, what types of pizzas are ordered, and what coupons they are using.
7-11 – Splunk allowed for the analysis of all point-of-sale transactions as well as allowing for the ability to combine it with data from other external data sources. It integrated Yahoo! Weather to predict the market demand for different products. Reporting has sped up more than one thousand fold.
City of Los Angeles – Used Splunk Cloud to stay within budget and uses Splunk holistically. The company can visualize structured and unstructured data to help find clues into potential cyber-security breaches.
Other customers – 85 of the Fortune 100. AAA, Adobe, Amaya, State of Alaska, Amaya Gaming, Atlassian, Blackrock, Bosch, CenturyLink, Coca-Cola, Comcast, Duke University, FINRA, Groupon, ING, Interac, Intuit, Jabil, Micron, NASDAQ, Nordstrom, Progressive, SAIC, Shazaam, SNAP, Staples, SurveyMonkey, Telenor, TransAlta, UbiSoft, UNLV, Vodafone and Yelp.
Financial Expectations for the coming quarters and years
Exhibit 8: Financial Forecast
Source: Perspectec
With their fiscal Q3 report in November, management raised their fiscal 2018 revenue expectations by 2% ($1.239 and $1.241 billion from $1.210 and $1.215 billion) and increased non-GAAP operating to 8.5% (was approximately 8%).
Our fiscal Q4/18 forecast takes into account management’s LTM average revenue guidance beat of 5.6%.
In addition, some customers will upgrade to 7.0 (launched in Sep 2017), which we expect will provide a boost in revenue.
For the first time, Splunk provided guidance for its next fiscal year. Management provides fiscal 2019 (ending Jan 2019) revenue guidance of approximately $1.550 billion and non-GAAP operating margin of 10.5%. We believe Splunk is able to provide guidance one year in advance due to its relatively low sales force turnover.
Exhibit 9: Big Data Comparable Companies As of December 29th, 2017
Source: Perspectec and Yahoo! Finance
We believe the key statistic to look at is free cash flow yield of a company’s market capitalization based on how the stock has traded recently. Splunk’s stock-based compensation has diluted its shares outstanding by 4.5% over the last 12 months, this is in-line with Tableau (5%) and Varonis (4%). These two companies have a business model which are most comparable to Splunk’s. That is perpetual licenses accounting for the large majority or all (in Varonis’ case) of license revenue.
While the current trailing 12-month free cash flow yield is only 1.6% for Splunk, (below the historical 2% yield), we expect that the yield would increase to 2.1% and 2.3% the following two reported quarters at the current share price and shares outstanding.
SaaS Valuation
As mentioned earlier, the company is expensive by any measure in comparison to other SaaS or subscriber based companies. Below is the graph of Splunk trades relative to other Enterprise SaaS companies.
Exhibit 10: Splunk is Expensive Relative to Enterprise SaaS Companies on a Customer Lifetime Value / Customer Growth Costs vs. EV/EBITDA basis
Source: Perspectec
While expensive in comparison to normal enterprise SaaS companies, it may be fairer to compare it on an Apples to Apples basis. Below we look at Splunk compared to other Big Data public companies whose license sales primarily come from perpetual (upfront) licenses rather than ongoing subscription sales.
Exhibit 11: Perpetual License Focused Big Data Companies Relative Valuation
Source: Perspectec
Splunk is the only company seeing a reasonable growth in the value of its customer base from investments in sales and marketing and R&D. At the same time, it is also yielding free cash flow of 1.6%.
Due to a large amount of revenue booked but not recognized on the income statement, we do not believe EPS and revenue are the best way to value the companies.
Price Target
Our target is on a fiscal Q1 2019 trailing 12-month free cash flow yield of 2%. Over the last year and a half, Splunk’s market cap has yielded about 2%. This free cash flow yield is at the average of where other Big Data perpetual license companies are currently trading.
The math is our estimated trailing 12-month free cash flow of $273.7 million in fiscal Q1/19 x 2% = $13.7 billion. Divided by an estimated 147.6 million diluted shares outstanding we get a target of $93 per share.
Actionable Conclusion
We believe investors should buy the shares prior to the fiscal Q1/19 report to be reported in May.
Important Disclosures and Disclaimer
This publication is produced by Perspectec Inc. This publication and the contents hereof are intended for information purposes only, and may be subject to change without further notice. Any use, disclosure,
distribution, dissemination, copying, printing or reliance on this publication for any other purpose without our prior consent or approval is strictly prohibited. Neither Perspectec Inc. nor any of its respective parent, holding, subsidiaries or affiliates, nor any of its respective directors, officers, independent contractors, servants and employees, represent nor warrant the accuracy or completeness of the information contained herein or as to the existence of other facts which might be significant, and will not accept any responsibility or liability whatsoever for any use of or reliance upon this publication or any of the contents hereof.
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This research report is not to be relied upon by any person in making any investment decision or otherwise advising with respect to, or dealing in, the securities mentioned, as it does not take into account the specific investment objectives, financial situation and particular needs of any person. Please refer to Persepctec Inc.’s terms of use disclosure and privacy policy https://perspectec.com/term_of_use
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For the purposes of complying with NYSE, NASDAQ and all Self-Regulatory Organizations, Perspectec Inc. has assigned the following rating system BUY, HOLD/NEUTRAL, SELL for the securities which are the views expressed by an analyst, Independent contractor, and or an employee of Perspectec Inc. The information and opinions in these reports were prepared by Perspectec Inc. or an analyst, independent contractor. Though the information herein is believed to be reliable and has been obtained from public sources believed to be reliable. Perspectec Inc. makes no representation as to its accuracy or completeness.
