Cloud computing has been a bright spot in 2020 amid the global pandemic and ensuing recession. According to tech researcher Gartner, global public cloud spending is expected to increase 6% from 2019 to reach some $258 billion -- then return to double-digit percentage increases in 2021 and 2022, in which time Gartner sees global cloud spending topping $364 billion.
This is the trend that underpins the thesis to invest in data monitoring and analytics platform Splunk (SPLK).
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An old dog learns new tricks
Splunk is an old player in the data monitoring and analytics industry. It's a crowded space that includes plenty of other old-timers as well as newcomers like Datadog (DDOG 1.19%) and Elastic (ESTC 0.74%). But while some of these newer data analytics firms like Datadog have caught up to Splunk as far as market cap goes, Splunk remains far and away the industry leader by revenue.
Data by YCharts.
In recent years, Splunk has had to update its data log and analytics software capabilities for use with cloud computing, and more recently has been transitioning to a customer billing model that better reflects modern needs. That has created some revenue recognition changes (cloud contract revenue is recognized over time versus an older term contract where revenue is recognized upfront). That is reflected in Splunk's 2% revenue decline through the first half of its 2021 fiscal year (six months ended July 31, 2020) to $926 million as the old term contracts get replaced with cloud contracts.
However, when using annual recurring revenue (ARR, new cloud plus old term contract sales), Splunk's total ARR at the end of the second quarter was up 50% from a year ago to $1.93 billion -- driven by an 89% increase in cloud ARR as more customers transition to the new billing model. And over the next two years, Splunk expects ARR to grow an average of 40% a year and reach $4.6 billion in fiscal 2023 (calendar year 2022), and generate operating cash flow of roughly $1 billion.
A reasonable price for an enduring growth story
Clearly Splunk's growth story remains intact, though the company's expectations for itself the next two years are higher than Gartner's projections for the industry overall -- specifically, for cloud application infrastructure, cloud system infrastructure, and security spending to increase 66%, 61%, and 25% from 2020 to 2022.
If Splunk is to more than double its revenue, the story the next two years will revolve around the company being able to scoop up more market share. Data analytics and cloud monitoring is a rising tide that will float many boats, but Splunk's large and still-expanding platform and tenure in the industry looks promising. And though its revenue isn't growing as fast as some of its peers at the moment (Datadog reported 68% year-over-year growth in the second quarter, and Elastic 44%), looking at the ARR picture and outlook for Splunk clears up some of the seemingly wide disparity.
As of this writing, Splunk stock has pulled back some 20% from all-time highs and trades for 12.1 times trailing 12-month sales. By comparison, some of its peers are going for far higher, like the more than 50 times trailing revenue valuation for Datadog. Besides the flat revenue performance this year during its cloud transition, part of the discount is also likely due to the $2.06 billion in cash and equivalents but $2.25 billion in debt on Splunk's balance sheet. Its smaller peers have net positive cash positions.
Nevertheless, Splunk is quickly returning to profitability as it updates its business model and is on a path to reaching operating profit margins of about 20%. Given the long-term positive outlook for the industry Splunk plays in, this stock remains a buy on my list and is a value compared to other data analytics stocks out there.
