Splunk Stock Forecast: Calm With a Chance of Volatility
Unless you’ve served time in some of America’s toughest corporations, you probably won’t know what the food chain looks like. At the very top of the hierarchy sits the Board Of Directors (BOD), a group of people who are elected to represent the interests of shareholders. Heading up this group of people is the Chairman of the Board. The Chief Executive Officer (CEO) of a corporation reports to the BOD, which is why it’s a conflict of interest when the CEO also happens to be the Chairman of the Board.
When a CEO leaves a company, our first inclination isn’t to think they’re leaving a sinking ship, especially if the company might be seen as underperforming. A lot can be implied from the climate surrounding the CEO’s departure, the language used to convey the departure, and the series of events leading up to the announcement. Look no further than what happened today with one of our portfolio companies, Splunk Inc. (SPLK).
The short story is that Splunk CEO Doug Merritt did exit, and Splunk shares did sell off, a plunge of about -18%. But if we put some context around this picture, we see that nothing has really happened since the last time Wall Street panicked. Here are the events we’ll talk about today, along with the share price at the time they took place, starting with the departure of Splunk’s Chief Technology Officer (CTO).
- April 2021 – Splunk CTO resigns to become a venture capitalist. Wall Street panics. Share price slides to $134 a share.
- Jun 2021 – Leading tech private equity firm Silver Lake announces $1 billion investment in Splunk. Wall Street applauds the move sending shares upwards to $139 a share.
- Nov 2021 – Splunk CEO is shown the door. Wall Street analysts panic. Share price falls to $138 a share.
Notice how there’s all kinds of action happening, but Splunk’s stock price doesn’t change much after the fact. (At the moment, our position is about par.) While we say the CEO was shown the door, we’re only implying that. From the horse’s mouth:
We determined now is the right time to transition to our next phase of leadership – in particular, the Board is focused on identifying a leader with a proven track record of scaling operations and growing multi-billion-dollar enterprises. That person is not me.Ex-CEO of Splunk, Doug Merritt
We may have made up that last sentence, but it seems fitting enough. Whenever a firm says the CEO is stepping down “effective immediately,” and that his boss will assume an interim CEO role while they look for a replacement, it’s reasonable to assume what happened. We’re also inclined to think that Silver Lake may have played a part in this.
Several months after Wall Street panicked over the departure of the CTO, one of the leading – if not the most prominent – tech-focused private equity firm, Silver Lake, made a billion-dollar investment in Splunk with a convertible notes deal that’s structured to show a payoff starting at $160 a share. In 2026, when the loan becomes due, Silver Lake can choose to convert $1 billion worth of stock into shares at the price of $160 a share. If shares are trading at $200 a share, that’s a cool $250 million in profit.
Silver Lake may see Splunk as an asset with significant upside based on historically poor performance. The numbers don’t lie.
Don’t let that early 1990s website fool you. Silver Lake is one of the world’s largest private equity firms with $88 billion in assets under management. So why would their Chairman, Kenneth Hao, join Splunk’s board for a $1 billion investment? Probably because they see a lot of opportunity and upside in Splunk, and probably because they needed a BSD to enter the room and make heads roll if need be. And that’s exactly what seems to have happened today. The BOD is responsible for the best interests of shareholders, and it’s clear they’ve been getting the short end of the stick for too long.
Checking Our Thesis
The last time we wrote about Splunk was back in April of this year in a piece titled Splunk Stock is Falling Along With Revenues. Why? At that time, we said the next check-in with the company would involve looking at the below key metrics:
- 2022 Revenue growth – anything around $3 billion and we’re smiling
- Progress moving from license model to cloud subscriptions – cloud is around 25% of revenues now and over 50% of new bookings.
- CTO replacement – sooner they get this sorted the better
The CTO was replaced with a senior fellow from Amazon, so we’ll assume that’s sorted. Regarding the first bullet point, that’s a bit misleading because Splunk uses fiscal years – a pointless accounting notion that does nothing but confuse people. We can simply look at how quarterly revenues have been faring since our last article. Here’s the before and after:
It may not look good on the tin, but this is why we prefer to invest in software-as-a-service (SaaS) companies. If we ignore revenue timing and simply focus on annual recurring revenue (ARR), growth is chugging right along. Here’s a look at Cloud ARR vs. Non-Cloud ARR for Splunk, including the Q3-2021 earnings results that were announced today.
The growth continues, and now cloud subscriptions make up nearly 40% of total ARR, up from 25% the last time we looked. There’s certainly some concern around cash burn, but we’re going to assume that Mr. Kenneth “Deep Pockets” Hao isn’t going to let the need for cash sink his pet ship.
Context is everything. If you bought shares of Splunk around their peak of $220 a share, you would be down -37% following news that the CEO was leaving. That won’t feel good. But regardless of whatever price you’re in at, the fact that Splunk continues to significantly underperform the broader market is disappointing. One can only hope that today, a major impediment to performance was removed.
Underperforming SaaS business models – especially ones that are being run incompetently – will always attract private equity sharks. Perhaps today’s announcement shouldn’t come as much of a surprise to Wall Street. Maybe it’s all part of Silver Lake’s master plan to get SPLK stock well above the $160 strike price. At least that’s what we’ll try to comfort ourselves with as the share price continues its volatile, yet somehow stable, path into 2022.
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