CAPScall of the Week: Splunk

For years, satirical late-night TV host Stephen Colbert has been running a series on his show called "Better Know a District," which highlights one of the 435 U.S. congressional districts and its representative. While I am no Stephen Colbert, I am brutally inquisitive when it comes to the 5,000-plus listed companies on the U.S. stock exchanges.

That's why I've made it a weekly tradition to examine one seldom-followed company within the Motley Fool CAPS database, and make a CAPScall of outperform or underperform on that company.

For this week's round of "Better Know a Stock," I'm going to take a closer look at Splunk (NASDAQ: SPLK  ) .

What Splunk does
Despite the odd name, Splunk is in the serious business of providing real-time software solutions that collect and index data from the virtual and IT cloud. Consider it the analytics hub of the cloud universe that helps companies better manage their networks.

In the fourth quarter, Splunk reported a 51% jump in revenue to $65.2 million as license revenue -- which accounts for more than 70% of total revenue -- rose 43%. A profit of $0.03 per share squeaked by Wall Street estimates that had only called for $0.02 in EPS. In addition to introducing a handful of new products, Splunk landed chemicals maker DuPont and security solutions provider Palo Alto Networks (NYSE: PANW  ) as its latest customers during the quarter. The deal with Palo Alto is particularly intriguing because Splunk's analytics will show businesses where their biggest network risks are, further enhancing the customization that's possible with Palo Alto's next-generation firewalls and allowing those businesses to maximize the protection of their networks.

The companies it competes against
The secret is out that businesses are willing to spend on big data center growth, so, as you might expect, competition within data analytics is fierce.

There are certain companies where I'd say Splunk presents a clear and concise advantage. BMC Software (NASDAQ: BMC  ) , for example, has fallen behind many of the mid-sized data analytics companies with regard to cloud-based analytics. BMC is aware of its need to make long-term transformative investments in its business to improve its analytics offerings, but rumors have been swirling for more than a week that it may instead be taken private

Splunk has also stolen a bit of the spotlight away from Oracle (NYSE: ORCL  ) , which disappointed analysts with a revenue shortfall during its third-quarter announcement last month. Make no mistake about it: Oracle's hardware issues continue to be a drag on its bottom line. But it also delivered a 2% decrease in revenue from software licenses and cloud subscriptions which would encompass data analytics. Oracle's report does present some concern that enterprises are tapering their spending as the rollout of Obamacare and higher taxes take hold.

However, one bigger fish Splunk has yet to fry is IBM (NYSE: IBM  ) , which has used its hardware and a buyout of Netezza in 2010 to roll out one of the fastest-growing data analytics platforms in the world. In spite of relatively tame annual results announced in January, IBM's two bright spots were a 13% spike in data analytics volume, and an 80% boost in cloud revenue. A company like Splunk is going to have a hard time competing against IBM's deep pockets and well-established partnerships.

The call
After carefully reviewing the prospects for Splunk, I've decided to make a CAPScall of underperform on the company.

To be honest, I've been thinking about a thumbs-down on Splunk ever since I read an article from my Foolish colleague Alyce Lomax, who cast doubt on the company's future in September. Alyce's focus on Splunk's hefty competition and lumpy revenue recognition had me questioning whether Splunk could keep its rapid growth rate up, or if it'd slow down dramatically.

The assumption I've come to is that Splunk could indeed be here to stay, but a combination of slowing enterprise spending and reckless expansion by Splunk will keep the company marginally profitable at best through 2014. From a valuation perspective, someone like me who often seeks out contrarian and deep-discount value plays is scared to death by Splunk at 20 times sales, 17 times book value, and (gasp!) 364 times forward earnings. Even looking further down the road and giving Splunk's growth rate the benefit of the doubt, Splunk is still more expensive than many of its comparably sized peers.

Unless we see a marked improvement in U.S. enterprise spending or Splunk drastically reduces its costs, it'll be three or more years before this valuation even comes close to making sense.

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