Splunk (SPLK) is one of the premier data analytics and cybersecurity software that can broadly be referred to as enterprise solutions. They specialize in data storage, indexing, and analyzing machine data. The software extracts the unreadable machine language and turns it into a human-readable format that gives users insights on anything from system failures to scheduling alerts. Simply put Splunk keeps companies running safely and gives them insights on customer activity on their platforms.

Now I know you might be thinking that the software is probably difficult to sell and deploy because it would likely require a complex overhaul from the client. However, that couldn't be further from the truth. The software is easy to deploy and it is able to process a wide range of data efficiently. It also has an app marketplace that allows clients to tailor the software to suit their business needs. They have on-premise and cloud-based solutions which allow the company to find a billing offering that suits the client's needs.

Stock image of cloud.

Source: Getty Images.

Cloud Headwinds

Splunk has faced some challenges with the cloud transition in the past. Investors have had to sit through poor performances by the stock while the company created what is now a very compelling product. It is likely that the shift was necessary for Splunk to remain competitive and it now looks like the worst is behind the company. The stock is currently almost 30% off 52-week highs which represents a great opportunity. 

Cloud Dollar-Based Net Retention Rate

Source: Splunk 

The strong Dollar-Based Net Retentions Rate (DBNRR) adds credence to the thesis that the cloud segment has turned a corner. A 129% DBNRR means that not only is the company likely retaining most of its clients, but its customers are paying on average 29% more than the prior period. This is a great indication that the new delivery model is catching on and investors should pay keen attention to the metric going forward.

Another challenge with the cloud is the gross margin when compared to the total gross margin. Investors shouldn't look down at a 60% gross margin but some improvement would be welcome down the line.

Total Gross Margin Versus Cloud Gross Margin

Source: Splunk

Splunk is currently in the tail-end of the cloud transition. Cloud transitions make sense for software as a service (SaaS) companies as it cuts down the time and cost of implementations on the client's side while allowing the company to scale quickly if the demand is there. The cloud is also a subscription-based offering versus the license option with the on-premise option. The license offerings require the customer to pay more upfront which suits some customers. The subscription option generates recurring revenue and may suit companies that need more flexibility from a cash flow standpoint. So we can clearly see the value the cloud pivot brings to shareholders. The drawback with these transitions is the cost. The company has really broad Partnerverse. It is affiliated with some of the biggest players in the space including AWS, Slack, and Zoom.

Cloud & Digital Transformation Trends Post Covid

The cloud is everywhere these days, and the market is still growing. The challenge is that a lot of potential clients don't fully understand the value cloud services can bring to their businesses. The pandemic has accelerated the digital transformation on a broad scale. A more socially distant world means more overall usage by Splunk's existing and potential customers which is a key theme in the cloud segment for quite some time. We can see from the revenue trends below that the cloud segment has been on a stellar run. According to the recent earnings call portion of the revenue growth has come from customers transitioning from the legacy on-premise offerings, which is supported by the chart below.

Steady Recurring Revenue growth

Source: Splunk

Splunk shareholders will be the first to tell you that its cloud transition has split opinions. The cloud pivot has put a drag on revenues for some time now but there are signs that the company may be coming through. The pandemic has accelerated the digitization of legacy operations and the cloud pivot now looks like a prudent move.

The Takeaway

Splunk is on the tail end of what could be the most important transition in its history. Profitability is on pause right now but this is a SaaS company with a top-tier product that has a price-to-sales (P/S) ratio of just 11. We are starting to see the light at the end of the tunnel and investors are getting a great starting point right now. Investors can feel good about an entry here. The turnaround may take some time, but patient investors should be excited about Splunk at these levels.