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Not too affiliated ago, Splunk (SPLK) appear its Q4 FY ’18 and full-year FY ’18 results, and those after-effects were about accustomed blithely by analysts and investors alike. Jim Cramer, for example, hosted Splunk’s CEO, Doug Merritt, on “Mad Money” and appropriate that Splunk is still in the “early innings” in acceding of growth.

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On March 27, 2018, the aggregation captivated an Analyst Day to altercate its performance, forecast, and action affective forward. Broadly, the aggregation laid out a acquirement ambition of $2 BB by FY ’20, with non-GAAP operating allowance advance forth the way. Its basal action – again, broadly speaking – revolves about a alteration to subscription-based licensing, added bazaar penetration, sales coverage, and growing the company’s billow business.

In this article, I advance elements of Splunk’s angle and action based on irregularities/risks that I accept are apparent through an assay of the balance alarm discussion, the Analyst Day presentation/discussion, and the company’s banking data.

The aftermost commodity I appear on Seeking Alpha – about eight months ago – discussed my acumen adjoin a Cisco (CSCO) accretion of Splunk. For affidavit aloft the ambit of this article, I absolutely hesitated to broadcast it. Ultimately, I did publish, and it elicited, shall we say, a able reaction. With best affect about Splunk agilely bullish, I apprehend this commodity and its absolutely bearish accent adeptness arm-twist a agnate reaction.

So be it. I reiterate from the above-mentioned commodity that I don’t accept Splunk is in its aboriginal innings of advance anymore, adverse to the position captivated by Mr. Cramer. That view, accompanying with the risks I altercate herein, led me to acclaim that absolute investors anticipate anxiously about their position.

As this commodity became a bit best than I originally expected, I broken it into numbered sections. While the sections do chronicle to anniversary other, some readers adeptness accede “moving between” sections, as against to account the commodity sequentially.

The commodity basis is as follows:

1.0 Overview and Basis (i.e. what you’re account appropriate now).

2.0 A Quick Attending At The Numbers

3.0 Operating Allowance Is… Uh… What Now?

4.0 Analysts/Investors Are Ignoring Risks About Licensing Mix

4.1 Cable Renewals Are Not A Layup

4.2 Authorization Archetypal Appulse On Operations

4.3 Authorization Archetypal Appulse On Boilerplate Accord Size

4.4 Accretion Up The Risks About Licensing Mix

5.0 Bazaar Action May Be Unrealistic

6.0 Don’t Calculation On Cloud

7.0 A Quick Attending At Cabal Trading Behavior

8.0 Conclusion

Finally, Splunk Annual Reports, which I reference, can be accessed here. I’m additionally including, forth with the article, Splunk’s balance alarm archetype and Analyst Day presentation, forth with acknowledging banking data:

Q4 FY 2018 Balance Transcript

Analyst Day FY 2019

Q4 FY 2018 Balance Press Release

Insider Trading

Before we dive in, let’s booty a quick attending at Splunk’s Q4 ’18/FY ’18 achievement as presented during its balance call. Splunk’s fourth division acquirement was $419.7 million, up 37% year over year, budgetary year acquirement was $1,271 billion, up 34% year-over-year, and billings additionally added healthily in both periods. But GAAP operating accident for the division was $23.9 million, and GAAP operating accident for the abounding year is $259 million.

Splunk FY ’18 Fourth Division Highlights

Splunk FY ’18 Abounding Year Highlights

Splunk acclaimed during its balance alarm that “for the abounding year, operating allowance was 9.2% aloft our expectations due to the backbone of our all-embracing top band performance.” The aggregation went on to say,

“…given our op allowance outperformance in budgetary ’18 and because the account we apprehend to accept from the agency changes, we are accretion our op allowance apprehension for budgetary ’19 to 11.5%, up from the 10.5% we ahead guided.”

I had originally planned to altercate operating allowance against the end of this article, but let us activate our assay there.

Splunk’s non-GAAP (keyword is “non-GAAP”) operating allowance was an important affair of altercation during the Analyst Day. Afore diving into the allowance discussion, I’d like to reiterate accession point I fabricated in my aftermost Seeking Alpha commodity discussing Splunk.

“Splunk’s bulk ratios are abnormally aerial abundantly due to stock-based agent compensation, which the aggregation omits for its non-GAAP results. But, investors should anxiously accede these non-cash costs. As Warren Buffett said in his FY 2015 Annual Report:

“…It has become accepted for managers to acquaint their owners to avoid assertive bulk items that are all too real. ‘Stock-based compensation’ is the best arrant example. The absolute name says it all: ‘compensation.’ If advantage isn’t an expense, what is it? And, if absolute and alternating costs don’t accord in the abacus of earnings, area in the apple do they belong?”

I animate readers to accumulate the point aloft in mind.

Moving forward, the company, like best added software vendors affairs cable licenses, will address after-effects beneath the new ASC 606 accounting accepted vs. the “old” ASC 605 standard. Beneath this rule, software companies are able to admit the abounding bulk of assertive cable licenses upfront. This is delineated in the accelerate below, presented during the Analyst Day:

Source: Splunk Analyst Day Presentation

This accounting change impacts Splunk’s appear income. For example, as per the accelerate below, beneath 606, absolute revenues for FY ’17 abatement from $950 to $944 MM, while revenues for FY ’18 access from $1,271 MM to $1,309 MM. We additionally see that non-GAAP operating allowance for FY ’18 increases from 9% to 14% beneath 606.

Source: Splunk Analyst Day Presentation

The purpose of this commodity is not to go into the intricacies of the new standard, although I appetite readers to assay the afterward for a acceptable overview: ASC 606 & IFRS 15: How the new Acquirement Standards will appulse Cable Companies – Zuora).

However, I do ambition to highlight some abnormality in acceding of how Splunk presented its operating allowance after-effects during the Analyst Day. The aggregation presented this accelerate to highlight non-GAAP operating allowance growth:

Source: Splunk Analyst Day Presentation

Now, accede the abstracts aloft in ambience with this slide:

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Source: Splunk Analyst Day Presentation

In the accelerate above, on the left, Splunk illustrates the operating allowance advance for FY ’18 beneath 606 from 9.2% to 14.2%. On the right, the aggregation illustrates how it arrives at its forecasted operating allowance of 11.5% for FY ’19, afresh beneath 606.

But now, attending aback at the operating allowance advantage accelerate area the aggregation appears to actualization non-GAAP operating allowance growth. The aggregation has alloyed after-effects from 605 and 606 accounting standards to actualize this advance curve. Specifically, in this slide, the 9.2% non-GAAP operating allowance aftereffect for FY ’18 is beneath 605, admitting the non-GAAP operating allowance forecasts for FY ’19 and FY ’20 are beneath 606. This accelerate is ambiguous in my view. It’s a bit like bond GAAP and non-GAAP after-effects together.

In fact, if we adapt the aftermost three abstracts credibility in this accelerate beneath 606, we accept the afterward (asterisk delineates forecast):

So, non-GAAP operating allowance is absolutely not anticipation to increase, it is abbreviating amid FY’ 18 and FY ’19 and absolutely about collapsed amid FY ’18 and FY ’20. During the Analyst Day Q&A period, one of the analysts (Walter) acicular out that the aggregation is staring at “flat margins with the aforementioned contour of revenue,” acceptation the top-line ambition of $2 BB by FY’ 20 has remained abiding over assorted Splunk forecasts. This analyst appropriate that conceivably the “missing link,” in acceding of why operating allowance is flat, is the company’s action about reinvestment initiatives. Dave Conte, Splunk Senior VP and CFO, replied as follows, which I transcribed from the Analyst Day webcast:

“So, at this time aftermost year, the $2BB anniversary was consistently beneath 606, so that alteration to subscription, which we laid out the aisle on that cable journey, was additionally axiological to that outlook. And at that time, the adviser that I provided was 12 to 14 percent. OK, so now that we’ve progressed, we’ve got a year beneath our belt, we’ve got 24 months to go, able-bodied 22 and a bisected months to go to that endpoint milestone, I’ve added the adviser to 14. And I anticipate the important allotment on this, this 606 acceptance is there’s a account from agency accounting, because we consistently had congenital in the transition, the 606 acquirement transition, that was consistently fundamental. The account for us is in the agency accounting, OK. That’s the allotment that we’re reinvesting. And the numbers I showed, again, I anticipate I said absolutely this isn’t guidance, but it’s as an example, OK the adviser is 11 and a bisected percent absolute operating margin. We get some account from alteration agency accounting which we are reinvesting in the initiatives represented by my colleagues on the date today.”

(If you’d like to accept to this accurate question/answer, it is about the 3:41 mark – that is, 3 hours, 41 minutes.)

Dave Conte’s acknowledgment to the catechism seemed rather aberrant to me. A simple acknowledgment would accept been forth the curve of “Yes; operating allowance is accepted to be about collapsed amid FY ’18 and FY ’20 due to reinvestment activity.” Moreover, Dave Conte’s acknowledgment does not explain why 605 and 606 accounting standards were alloyed on the operating allowance advantage slide, although, admittedly, he was not asked that specific question. Finally, it would accept been accessible if his acknowledgment explained why the aggregation has aloft non-GAAP operating allowance advice for FY ’20 from 12% to 14% (the 12% bulk was presented in FY ’17).

I’m anxious as to why the aggregation appears to conceal allowance achievement on the operating allowance advantage slide, in an accomplishment to actualize the actualization of growth.

Also, Splunk has provided through its own annotation some affidavit to anticipate that operating margins are at risk. As we will altercate added in the article, Dave Conte has declared that he expects cable authorization durations to affluence down. If that is so, an broker should admiration if that actuality is in battle with the added adviser for FY ’20. Afterwards all, the aggregation has adumbrated they intend to reinvest the capital bulk account that they accept beneath 606 (i.e. agency expense). So, if you are reinvesting your capital accounting benefit, and cable affairs – which will boss your authorization mix (we’ll altercate this in detail in a moment) – are accepted to be beneath in continuance and accordingly lower in value, area is the added operating allowance adviser advancing from for FY’ 20?

I additionally would admonish investors of Splunk’s GAAP operating allowance achievement from FY’ 2012 through FY’ 2018:

Data Source: Splunk Annual Reports FY ’13 – FY ’18, Blueprint Source: Yves Sukhu

GAAP allowance has been trending in the appropriate administration over the aftermost few years, but accustomed the altercation on non-GAAP operating allowance above, I’m anxious about a accessible reversal.

I reminded readers at the alpha of this area that Splunk backs out its rather ample stock-based advantage bulk to accomplish non-GAAP results. In fairness, the aggregation adumbrated during the Analyst Day that this bulk is normalizing:

Source: Splunk Analyst Day Presentation

While this may be so, it is the access of abetment out the expense, and not necessarily the bulk itself that is concerning. Accustomed the access to artful non-GAAP after-effects and accustomed how the non-GAAP operating allowance abstracts were presented/discussed during the Analyst Day, I abandoned am led to accept that there may be abundant accident about approaching operating allowance achievement (both GAAP and non-GAAP).

During the balance call, Splunk acclaimed that its “largest tailwind is appellation authorization bookings.” By “term license”, the aggregation is apropos to on-premise software licenses with a anchored continuance (e.g. one year, two years, etc.), which of advance is in adverse to a abiding authorization that a chump owns forever. To be clear, Splunk additionally sells cloud-based licenses which additionally accept a anchored continuance but are (obviously) acclimated in the cloud, and not on premise.

NOTE: Splunk about uses the chat “duration” to advertence its non-perpetual authorization types (term cloud). I will use “subscription” in this area and throughout the commodity as an agnate term.

Splunk is affective from a ascendant abiding authorization archetypal to a ascendant cable authorization model, with appellation and billow licenses accepted to comprise 75% of bookings by FY 2020.

Source: Splunk Analyst Day Presentation

This is not surprising, as the action software industry in accepted is affective in the administration of subscription-licenses over abiding licenses. However, let me inject a bit of claimed chestnut actuality which is accordant to the discussion: No software aggregation “wants” to move to subscription-based licensing over abiding licenses if the closing was how they were ahead selling. They are accomplishing it because they don’t accept a choice.

Analysts on the balance call, as able-bodied as those accommodating during the Analyst Day, seemed to be about admiring with Splunk’s growing allotment of subscription-based licenses aback none brought up any aloft objections/concerns. It’s reasonable to accept that analysts accept Splunk will abound its subscription-license revenues at an accretion bulk that exceeds the crumbling bulk of abiding licenses. On the surface, acquirement and sales abstracts accept to abutment that belief. First, Splunk’s top band has affiliated to abound at an absorbing rate, and software authorization advance accurately has developed at a 44% CAGR aback FY 2012.

Source: Splunk Analyst Day Presentation

Source: Splunk Analyst Day Presentation

Second, Splunk’s boilerplate sales bulk has added steadily.

Source: Splunk Analyst Day Presentation

These trends accept occurred as the authorization mix has been shifting. However, a added assay exposes abeyant issues that analysts/investors may be overlooking and avoiding.

Stating the obvious, barter like subscription-based licenses aback they acquiesce costs to be advance out over time (i.e. against a audible up-front acquittal for a abiding license).

Customers additionally like subscription-licenses from the standpoint of attached their “lock-in” with any accustomed vendor. Arguably, barter are beneath acceptable to leave a technology for which they accept a abiding license, accustomed the attributes of the authorization itself, as able-bodied as the (likely) large, upfront bulk that they paid to access the license. Aback cable licenses are acting by definition, barter may be added inclined, at the end of their authorization terms, to accede their options.

As I see it, herein lies the claiming for Splunk (and abounding added software companies) accustomed the about-face to added subscription-based licenses.

The company’s re-subscription bulk “may” abatement over time as competitors and new bazaar entrants accord barter abeyance afore committing to accession cable period. In its FY 2017 Annual Address on folio 19, Splunk states:

“Any abatement in our chump renewals could abnormally affect our approaching operating results…(Much) of our software is awash beneath abiding authorization agreements…In adjustment for us to advance our operating results, it is important that our absolute barter renew their appellation licenses, subscriptions and aliment and abutment agreements aback the arrangement appellation expires Our barter accept no obligation to renew their appellation licenses, subscriptions or aliment and abutment agreements with us afterwards the acceding accept expired.”

As mentioned above, chump preferences accept abashed against subscription-based licensing absolutely because they do not appetite to be bound into technologies over assorted years. Conceivably controlling administration alongside makes this point on the FY ’18 Q4 balance alarm area David Conte stated:

“We apprehend continuance to affluence bottomward as the (subscription license) basin gets larger.”

He goes on to say:

“The archetypal behavior for barter beneath a cable arrangement is to pay annually.”

As best I can tell, Splunk does not accommodate abstracts on their assimilation ante for cable licenses. But, the “law of competition” dictates that assimilation ante “should” abatement over time. Of course, by how abundant and how fast is difficult to answer. From a top-line perspective, Splunk’s advance in cable acquirement charge acutely be greater than any declines due to subscriber loss.

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Moreover, Splunk may appear beneath burden to renew chump subscriptions at an accretion affluence if cable periods abide to “ease down.” You adeptness altercate that the cable aeon will eventually adeptness a “bottom” because Splunk artlessly will not address cable affairs for beneath than a accustomed continuance (e.g. one year). I accede with that argument. However, let us afresh anticipate about the accessible aftereffect of advancing pressures. If competitors opt to move into shorter-duration cable affairs (e.g. month-to-month), Splunk may accept no best but to chase suit.

Granted, what I accept accounting aloft is speculative. But I’d altercate that it is “reasonably probable.” I accept analysts and investors are bold (incorrectly) that subscription-based acquirement will abide to abound afterwards any cogent subscriber loss. This is a chancy assumption, to say the least, in the face of a awful airy and advancing market.

To abutting this section, I agenda that not one analyst on the balance call, or during the Analyst Day Q&A period, asked about cable assimilation ante (historical or forecasted).

Let’s additionally anticipate about the move to a subscription-dominant licensing archetypal from a structural perspective. Splunk anon has a “heavy” absolute sales force, with sales/marketing costs accounting for about 64% of absolute revenues in FY ’18. It may prove difficult to abutment that affectionate of sales archetypal on a advantage of short-duration affairs because of the abeyant airheadedness in revenue. If the acquirement mix is action to favor shorter-duration subscription-based affairs affective forward, afresh Splunk will acceptable access burden on its accepted sales model. It would accept Doug Merritt, Splunk CEO and President, hinted at this point on the balance call, afresh – afterwards advertence it directly, saying:

“…we could accept a growing and added able and monetizable ecosystem of partners…and affiliated sales migration…from a abundant absolute to a abundant added attenuated group.”

(Readers are encouraged to assay the abounding archetype for context.)

Abstracts Source: Splunk Annual Reports FY ’13 – FY ’18, Table Source: Yves Sukhu

As we see above, sales and business has been Splunk’s bigger operating expense. Does Splunk charge a absolute sales archetypal to survive? Apparently yes, unless they’ve enjoyed ambience a bout to bags of money over the aftermost several years. Moreover, as will be discussed afterwards in the article, Splunk intends to acuminate its focus on markets alfresco its bulk IT Operations (ITOM) and Aegis markets via sales coverage.

It seems reasonable, therefore, to accept that sales and business costs will abide to be the bigger operating bulk affective forward. It should be acicular out that historically Splunk’s adeptness to abutment such an big-ticket sales force has adequate on a licensing mix that was bedeviled by abiding licenses. So, the company’s adeptness to advance its accepted sales anatomy on a advantage of cable licenses is cryptic and “untested.” That’s not to say that it cannot be done. But, it is a cogent risk.

Let’s revisit the accelerate that Splunk presented on Boilerplate Affairs Price:

Source: Splunk Analyst Day Presentation

It’s an absorbing chart, abnormally as boilerplate affairs bulk has added than angled aback FY ’12. As the aggregation implies in this accelerate (and states absolutely elsewhere), added chump acceptance over time is active the advance in ASP. Conceivably akin added absorbing is the blueprint announcement the cardinal of deals over $1 million:

Source: Splunk Analyst Day Presentation

Naturally, an affluence of ample accord sizes helps to access the all-embracing ASP. Evidently, Splunk believes the trend in ASP advance will abide in animosity of the change in licensing mix. ASP is acutely important, as it is a key ascribe into maintaining/growing operating margin. Will Splunk’s trend in ASP continue?

I see four abeyant problems.

1. The aboriginal botheration lies with the adeptness for the aggregation to abide active action acceptance agreements (EAAs). The aggregation defines EAAs as follows in its FY ’17 Annual Report:

“From time to time, we additionally access into affairs that are advised to accredit ample acceptance of our software aural an enterprise, referred to as action acceptance agreements. These agreements about accommodate accoutrement that crave acquirement cessation and acceptance over time.”

Per the aftermost slide, Splunk has done a acceptable job demonstrating advance in these types of contracts. And the aggregation adeptness able-bodied abide this trend. However, there are a brace abeyant issues with EAAs:

A abatement in EAA acquirement accumulated will annoyance on ASP. In fact, Dave Conte accustomed that “bubbles” are accessible with EAAs in his presentation during the Analyst Day. But he additionally adumbrated that he abandoned believed Splunk’s EAA advance will continue.

2. The added botheration lies in the boilerplate bulk of cable licenses. Boilerplate cable authorization bulk will be beneath than the boilerplate abiding authorization value, and Splunk acclaimed during the Analyst Day that their banking models are congenital on the acceptance that cable licenses will be about two-thirds the admeasurement of a abiding license. (I do leave accessible the achievability that there could be some almighty ample cable authorization sales.) If abiding licenses become the aboriginal allotment of the “license pie,” then, beneath one scenario, the boilerplate abiding authorization accord admeasurement will accept to access to atone to advance ASP. Simply, the dynamics of the new licensing mix may accomplish it added arduous for Splunk to maintain, abundant beneath abound its ASP.

3. Advancing pressures are acceptable to drive bottomward the boilerplate bulk of all authorization types (subscription and perpetual). Accede the afterward account from Splunk’s FY ’17 Annual Report:

“During budgetary 2015, we added the authorization accommodation of our entry-level licenses for Splunk Action and decreased the bulk of Splunk Cloud. Although we accept that this bulk abridgement will accredit our barter to added rapidly access their adeptness to accept our offerings, there is no agreement this will occur. It is accessible that such bulk abridgement will not be account by an access in adjustment volume, which would accept the aftereffect of blurred our revenues and abnormally impacting our banking results.”

These appraisement and licensing moves advance a acknowledgment to advancing pressures, unless, of course, Splunk was action decidedly acceptable in 2015. These pressures will abandoned get worse.

4. Splunk had an almighty ample cardinal of “mega-orders,” above than $10MM in FY ’18:

Source: Splunk Analyst Day Presentation

These “mega-orders” were not backed out aback artful ASP. Arguably, the ASP for FY ’18 is artificially aerial due to the access of these absolute ample orders, which acutely actualization abundant aberration in acceding of their cardinal year over year in the accelerate above. As with EAAs, there’s a assertive subset of Splunk’s all-embracing chump abject that can “absorb” such a ample transaction. I accept no abstraction how ample that subset is, so conceivably Splunk has abounding added opportunities to advertise such ample deals. An analyst (Jesse) inquired about the abnormal cardinal of ample orders in FY ’18 and asked why it happened and if investors should apprehend that affectionate of ample adjustment achievement affective forward. Dave Conte replied that he could not say it was a “new normal” and offered no account as far as why so abounding ample orders were candy in FY ’18. Accordingly, investors should be able for animation in acceding of the cardinal of these affairs accomplished year over year.

If we accumulated the capital credibility of sections 4.1, 4.2, and 4.3, Splunk’s top-line, operating margin, and absolute operating anatomy (among added things) are at accident as the aggregation accouterment against a subscription-dominant authorization model. Certainly, and adverse to accumulated I accept presented in this section, the aggregation could:

My capital affair is that the licensing archetypal risks backpack a weight that’s not reflected in analyst questions/discussions with Splunk. Yes, some analysts accommodating in the Analyst Day hinted at some licensing mix concerns, as discussed above. But none absolutely challenged the company, which I anticipate was a disservice to investors.

Splunk afresh alleged absorption to its absolute addressable bazaar befalling during the Analyst Day. Actuality is the accelerate presented:

Source: Splunk Analyst Day Presentation

Almost every data-centric aggregation has a accelerate like this. The anecdotal is consistently the same:

The bulk of abstracts advance is so aerial that our addressable bazaar befalling is accretion like crazy!

This affectionate of cerebration is misleading, and investors should be astute to it. As any bazaar expands, antagonism will accent – barring a monopolistic opportunity, which Splunk does not accept in any market. So, while the all-embracing bazaar admeasurement grows, the “slice of the pie” that any accurate bazaar actor can advance may absolutely be accepting smaller. So, the accelerate aloft is absolutely absurd from an investor’s standpoint afterwards the ambience of a abundant advancing analysis. It is notable – not in a acceptable way – that Splunk did not action any abundant altercation on antagonism during the Analyst Day, nor did any of the analysts claiming the aggregation in absorption to advancing pressures.

Splunk calculates its accepted TAM by accretion the estimated bazaar admeasurement of the bristles capital band-aid areas that the aggregation is targeting. Splunk additionally mentioned the admeasurement of these markets in the above-mentioned budgetary year (FY ’17) to accent not aloof the arduous admeasurement of their TAM but the able advance bulk as well. The abstracts presented from the Analyst Day is as follows:

Within its two bigger markets, IT Operations (ITOM) and Security, the aggregation acclaimed during the Analyst Day that it has abandoned accomplished 2% and 6% penetration, respectively. (Assuming they beggarly that in acceding of sales volume, afresh Splunk generated about $460 MM for IT Operations use cases and about $660 MM for Security.)

All of this, according to Splunk, agency the aggregation has a massive befalling in advanced of it.

But I’m abashed by Splunk’s action which is to “play” in all bristles markets of the table. I appear aback to my animadversion about accumulative competition. Let’s attending at Splunk’s two bigger markets of IT Operations (ITOM) and Aegis area – in their words – they accept abandoned aloof started to access and abduction bazaar share. Splunk is hardly abandoned in either of these markets. While they are appropriately a baton in both areas, accede some of the added “heavyweight” players in both markets:

As an investor, would you not apprehend that all of the companies aloft are action to abide to aggressively attempt in these markets as they grow? Why would any of these companies agreeably abalienate any ground/market allotment to Splunk? And these companies are aloof the heavyweights. There are any cardinal of startups/niche players that appetite a bigger allotment of the pie. For example, for the Aegis amplitude (specifically, the SIEM amplitude area Splunk is a leader), here’s Gartner’s abracadabra quadrant:

There are absolutely a few alcove players who apparently appetite to move “up and to the right.” If Splunk has abandoned penetrated the ITOM bazaar at 2%, the Aegis bazaar at 6%, has cogent bazaar admeasurement in both markets but additionally has cogent antagonism in both markets, wouldn’t it accomplish faculty to bifold bottomward and focus on these markets? Moreover, both the ITOM and Aegis markets are alteration from a technology perspective. As a (possibly oversimplified) example, aegis has confused from once-upon-a-time simple accident capture/monitoring to circuitous action analytics area software is tasked with interpreting the “meaning” of assorted system/network action and abstracts to ascertain threats. The closing is not accessible to do and is why Splunk has fabricated assertive investments in the Aegis amplitude over the aftermost few years, including the afresh appear accretion of Phantom (an InQTel backed company).

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I don’t accept why Splunk would try to advance bristles markets, when:

One analyst (Michael) offered one catechism forth this band of cerebration during the Q&A area of the Analyst Data, allurement “why now” in acceding of emphasizing a focus on business analytics and IoT markets. Doug Merritt broadly responded that the aggregation “really hadn’t put anyone on business analytics and IoT” and that Splunk needs to “put (its) money area (its) aperture is, and accretion repetitive patterns in those amplification areas.”

In acceding of business analytics, Splunk has had this bazaar on its alarm aback its aboriginal year as a accessible company. The afterward is from the company’s FY ’13 Annual Report:

Most of our barter currently use our software to abutment appliance management, IT operations, aegis and acquiescence functions. Our adeptness to abound our business depends in allotment on our adeptness to actuate accepted and approaching barter to aggrandize their use of our software to added use cases, such as accessories management, accumulation alternation management, business analytics and chump acceptance analytics.

So, actuality we are several years later, and the aggregation is suggesting that business analytics hasn’t been a focus, nor accept they accustomed a repeatable sales arrangement for this market. If that’s true, what makes Splunk anticipate they can akin be advancing in the business analytics bazaar now? Business analytics is hardly a beginning market, and has become awfully saturated. Some of the aloft players include:

The account aloft doesn’t akin accede players like (NYSE:CRM), which alien its Wave Analytics alms not too affiliated ago, and Amazon Web Casework (NASDAQ:AMZN), which apprenticed with Zoomdata (another InQTel backed company) to advance its QuickSight offering. Conceivably this assimilation is reflected in Splunk’s own data, as the TAM table shows collapsed advance in the business analytics market.

So, why is Splunk targeting a bazaar where:

It doesn’t accept to accomplish a lot of sense.

In absorption to the IoT market, it is so ambiguous appropriate now that it is adamantine to apperceive what it is, and what it isn’t. Aftermost year, I had accounting a Seeking Alpha commodity about Accepted Electric (NYSE:GE) area I acicular out the huge variations in IoT bazaar admeasurement estimates. I should agenda that GE, in fact, has a affiliation with Splunk for its own IoT initiative. There’s little agnosticism that, as the arduous cardinal of affiliated machines and accessories grows, afresh the abstracts accumulated they bandy off will grow. But, to reiterate, it is somewhat difficult to quantify the befalling here. For example, bend accretion is accession buzzy boiler these days, area machine/device abstracts is not “sent” to a axial abundance like Splunk for assay but is rather analyzed/interpreted “near” the machine/device, or on the machine/device itself. So, aloof because the accumulated of abstracts is growing does not necessarily beggarly that all that abstracts is action to be transmitted, stored, and analyzed in aggregate. The broader point in my commodity on GE – which I anticipate is additionally accordant actuality – was that the aggregation (GE in that case) was throwing about (what I perceived as) antic numbers in absorption to their IoT bazaar opportunity.

The appliance development bazaar offers agnate characteristics to the business analytics bazaar in that it has accomplished a assertive akin of ability and appearance several ample players.

With a accumulated $34 billion bazaar befalling in its bulk markets (using Splunk’s own numbers), I’m at a accident why the aggregation would akin accede accession its resources. Anticipate about this from the standpoint of analysis and development (R&D):

Data Source: Splunk Annual Reports FY ’13 – FY ’18, Blueprint Source: Yves Sukhu

The trend in Splunk’s R&D absorb about to acquirement is clear. Investors should ask themselves: How can the aggregation finer advance these bound R&D assets above bristles audible markets, anniversary of which appeal specific R&D advance and are awful competitive?

As per Doug Merritt, the aggregation intends to put assets on amplification markets. Aback the aggregation acutely believes in a direct-sales-oriented access for advancing markets, will Splunk appoint added salespeople to focus on business analytics, appliance development, and IoT? Area will the money appear from for that? How will the aggregation advance its operating allowance advice if it expands sales?

I’m affected to ask: does Splunk accept or apprehend problems with its bulk markets (ITOM, Security), e.g. saturation, accumulative competition, etc.? If so, that would be awkward to say the atomic from an broker standpoint.

Splunk accustomed its billow business abundant times during the Analyst Day presentation and during the associated Q&A section. The aggregation is relying on the billow business to atone for crumbling abiding authorization revenue, and to additionally advice it abduction added customers.

Let’s focus on the acquirement aspect of this business first. Splunk estimates its billow business will be breeding $250 MM by FY ’20:

Source: Splunk Analyst Day Presentation

I accept some doubts about this. Aboriginal of all, the aggregation appears to be extrapolating a trend based on two aloft abstracts credibility (i.e. FY ’17 and FY ’18 performance). So, their experience/history with cogent revenues from their billow business is limited, which – one would anticipate – makes it difficult to forecast. Further, anticipate about one of the defining characteristics of cloud-based solutions:

They tend to get cheaper over time.

Did Amazon Web Casework (AWS) become the 800,000 batter apache that it is by charging MORE for the assorted casework it provides? No, of advance not. It captured allotment by badly under-cutting acceptable IT band-aid providers. I bethink signing up for AWS in the aboriginal days, aback I’d accept – every brace weeks or so – an email account a affiliated bulk abridgement of some accurate AWS resource.

I actively agnosticism Splunk will be able to advance its appraisement in the cloud. Investors should apprehend cogent competition, because, afterwards all, it is the “easiest” ambiance for competitors to access due to such a low barrier to entry. Today, Splunk enjoys a able accord with AWS, but, let me affectation accession catechism to readers:

Why shouldn’t AWS annihilate Splunk?

Think about Splunk in acceding of bulk capabilities: It is about a arrangement for abstracts collection, abstracts storage/retrieval, abstracts correlation, and abstracts visualization. AWS has capabilities in all these areas, and more. They accept greater development assets than Splunk. So, again, why shouldn’t they annihilate Splunk altogether?

Doug Merritt didn’t absolutely accomplish this point on the Q4 balance call, but he acclaimed “AWS’ job is to abide to action added and added services, both basement and belvedere services, to the community.” He goes on to accurately agenda “and our job is to accumulate abacus added bulk on top of those casework so that bodies would still appetite to do business with Splunk in accession to, or with, AWS. And that’s aloof – that’s a bold that we all apperceive how to comedy in tech.” Mr. Merritt is 100% appropriate in his comments. But, if I were an broker in Splunk, I would be acutely anxious that the company, which is cogent me billow is bulk to its approaching advance strategy, could be dead off by its better billow partner. Splunk’s “competitive moat” about its billow business does not attending abysmal or wide.

Naturally, if Splunk is affected to bead appraisement in the billow due to advancing pressures, afresh the aggregation will accept to advertise added deals to accomplish up the aforementioned bulk of revenue.

Splunk additionally is counting on the billow business to advice the aggregation accomplish its chump ambition of 20,000 by FY ’20. As we see below, the bulk of advance in Splunk’s chump calculation has decreased and flatlined somewhat:

Data Source: Splunk Annual Reports FY ’13 – FY ’18, Blueprint Source: Yves Sukhu

One analyst (Ramo – I’m not abiding about the name spelling) commented about this during the Analyst Day Q&A advertence that he was “struggling” with the actuality that Splunk has been abacus (more or less) 2,000 added barter per year. He accurately asked: “What’s the affair that’s befitting that cardinal area it is? Is it advance generation? What’s the disciplinarian to accompany that higher?” Splunk provided abundant answers to the question, but the acknowledgment accordant to this area came from Sendur Sellakumar who commented that Splunk looks at its affiliation with AWS as a apparatus to abduction new customers. Additionally, and discussed beforehand during the Analyst Day, Mr. Sellakumar, remarked that one of the strategies to drive business advance with AWS is to accept “(Splunk) reps allocution with their reps.” This action is logical, but not necessarily sustainable.

It’s absolutely acceptable that the accomplished trend in new chump accretion via AWS decreases over time for the affidavit discussed above. I accept that such a activating may not appear in FY ’19 or FY ’20, but I anticipate it is still probable. With account to the access of active a able accord amid the corresponding AWS and Splunk sales forces, this makes faculty But, don’t you anticipate that every added AWS accomplice wants to do the aforementioned thing? As affiliated as AWS charcoal “king of the cloud,” everybody will “want a piece” of their sales aggregation to drive advance and sales of their products/solutions. Splunk will be advancing with abounding vendors for the “mindshare” of AWS reps.

Splunk has corrective a aflush account of its billow business. But I accept it is acceptable not to accomplish or abound with the backbone or robustness that has been communicated. It may not be acceptable over the affiliated term.

Given all the risks I accept acicular out in this article, I was analytical to analyze cabal trading action for Splunk. In effect, I wondered if there were any patterns that adeptness betoken assembly are anxious about risk. I looked at action from April 2012 (the ages Splunk banal aboriginal traded) through today, appliance abstracts from

I begin that:

In absorption to the aboriginal bullet, we all apperceive assembly usually access shares via grants/options. So, the actuality that no assembly fabricated any accessible barter purchases adeptness bang investors as a “nothing to see actuality nothing-burger.” Still, if these assembly accept so acerb in the company’s befalling and prospects, one adeptness apprehend to see at atomic some accessible bazaar allotment purchases. In absorption to the added bullet, it is acutely accepted for assembly to access into predefined disposition plans. But that’s not to say that an cabal has to access into a disposition plan. Again, bold there’s able acceptance in the company’s abiding opportunity, why access into an advancing disposition plan in the aboriginal place?

Splunk’s banal bulk over the aftermost 12 months has reflected an about cult-like activity from investors and analysts:

Source: Inveyo

Frankly, it would not abruptness me to see the banal abide to analysis new highs throughout the butt of the agenda year. But I accept such bulk movements would be absolutely broken from the basal business and associated risks.

I accept Splunk’s bazaar befalling and advancing operating anatomy may not be as applicable as offered by the aggregation and analysts alike. Further, abounding analysts, decidedly those on the FY ’18 balance alarm and accommodating during the Splunk’s Analyst Day, accept to abridgement a alertness to absolutely claiming the aggregation on credibility discussed in this article. Consequently, aloft risks are not – in my actualization – actuality appropriately discussed and analyzed by the advance community.

Lastly, I’m afflicted by the company’s presentation of non-GAAP operating allowance after-effects during its Analyst Day which I acquainted was misleading. It suggests to me that advancing operating achievement may be at risk.

With accepted bazaar altitude for the tech area overwhelmingly bullish, a bearish articulation is acceptable to be drowned out rather quickly. So, I apprehend abundant of what I accept laid out actuality to be absolutely ignored. Nonetheless, for the baby boyhood of Splunk investors attractive aloft bulk momentum, I appetite you to be cautious.

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