Ian King is out with another promo for his Automatic Fortunes newsletter published by Banyan Hill, and like most such “presentations” he makes some huge predictions to tantalize you with dreams of wealth. And though it sounds an awful lot like the “most important tech stock of 2019” pitch he was making last fall, I thought I should dig in and give it another look-see.
They’re also (again) being a bit sneaky with the offer they’re making, so make sure to read the fine print if you actually subscribe… the newsletter is pitched as being $79/year with all the “special reports,” but your subscription also comes with a “free” three month trial of Jeff Yastine’s Total Wealth Insider, so if you don’t cancel that “trial” and let the autorenew happen, you’ll end up paying $194 a year for the two newsletters. Surprise!
So once again I’ll put on my muck boots and dig through the clues King drops, see if we can ID the stock for you, and leave it to you to decide whether you want to research the stock more… or even subscribe to the newsletter if you so choose.
It’s all about “big data,” and King’s spiel basically builds on the fact that data will be the driver for all the other hot tech “stories” in the next few years…
“Michael Dell calls this master technology the next trillion-dollar opportunity.
“The former CEO of Intel proclaims it’s ‘the new oil’ ….
“This master technology will be bigger than artificial intelligence. Bigger than 5G. Bigger than self-driving cars. And bigger than the Internet of Things.
“And it is all but guaranteed. Because without it, none of these other technologies can even exist.”
The biggest opportunity ever? That’s the implication from the ad…
“…. we will never see a technological revolution like this again in our lifetime.
“Which is why my team and I spent the last year finding the best way to profit from this single opportunity.
“And after months of research, data refining and investigating … we’ve done it.”
Ah, so what is this “best way to profit?” More from the ad:
“We’ve pinpointed a little-known company in the heart of Silicon Valley that holds the key to unlocking this new technology … giving investors the chance to profit from a massive 18,767% industry growth.
“And that growth isn’t hypothetical … it’s practically guaranteed.”
Did you read that as “you’re guaranteed to have 18,767% returns?” Congratulations, you’ve just made an ad copywriter very happy!
We get a little spiel about how important and huge “big data” is…
“Big Data is what we call this mass of digital information that can be analyzed to reveal patterns, trends and associations … but most folks are unaware of how large Big Data really is.
“Consider this … 90% of all the data in human history … dating back over thousands of years … has been generated in just the last two years alone.”
And hints about a few of the big winners the market has already produced…
“Talend, a Big Data cloud-computing company, has already shot up as high as 136%…
“Alteryx, a company that helps businesses blend data from several sources, has soared to a peak of 533%…
“And Oracle, another Big Data cloud company, has soared as high as 1,633%…
“And as great as those gains are, the opportunity in front of you today — this little-known California-based company — could be even bigger.”
“Big Data” is a complex idea, all about collecting, processing and monitoring machine-generated data — whether that’s customer shopping behavior or temperatures in power plant boilers or airplane arrival times or millions of other data points — and turning that data, most of which is never looked at or used at this point, into something useful or actionable. King uses an oil metaphor to try to explain…
“In fact, industry insiders are proclaiming that…
“Big Data Is the Oil of the 21st Century
“That it is the new ‘raw material of business’…
“And that it could even ‘change the world’….
“So much new data is being created that 80% of it is currently worthless. We call it ‘crude’ data because it’s collected and stored until we know what to do with it.
“This crude data, sitting on servers, is like having billions of barrels of crude oil just sitting around.
“It’s useless until it’s refined by analytics into what I call ‘digital gasoline’ — information that can actually be used to generate profit.”
So, naturally, this company he’s teasing is a “refinery” for data…
“Their data-refining software is going to absolutely change the game.
“So much so, they’ve already become known as the ‘Google for IT (information technology) data.’
“Which is why this company has been building a massive customer base … from around 3,700 companies when it went public in 2012 to more than 16,000 today.
“The list includes 90 of the Fortune 100 companies.
“It boasts clients such as Coca-Cola, Comcast, Groupon and Nordstrom. Even data giants Amazon, Google and Microsoft use its software.
“So it’s no mystery why annual sales have soared a massive 300% over the last five years.”
OK, so those are some good clues… what else?
“What’s amazing is that most companies’ growth slows down as they get bigger … but with this company, the growth is actually accelerating.
“That’s higher sales growth than Google (108%), Amazon (162%) and Apple (45%) … combined!
“As one investment analyst commented: ‘Its numbers are truly mind-blowing,’ and another said it’s ‘a cutting-edge firm in the field of machine data’….
“It’s no wonder that 31 analysts recently gave this stock a massive buy/outperform rating, while only one gave it an underperform rating.”
He also throws in Warren Buffett’s favorite term, the “moat” that defends the best companies from competition:
“And here’s something you will really like. They have a moat. They basically own the data-refining field with more than 200 patents, and 500 more are pending. In other words, they have a near monopoly over the expected 18,767% growth.”
We also get some big-picture growth stuff, expanding on that 18,767% growth number….
“According to Scientific American magazine, every company in the world will need a data refinery … basically forever….
“And as the data economy grows in importance, data refining could blossom into a massive new industry … from a $5.3 billion niche to a potential trillion-dollar mega industry … soaring over 18,000%.”
And one final tantalizing promise…
“And this company will be leading the pack … that’s why I believe it could grow more in the next year than Amazon, Facebook or Google have grown in the last 10 years.”
Man, can’t you feel the sweat beading up on your forehead just imagining that? Facebook has had 1,600% revenue growth since going public less than a decade ago, and Alphabet and Amazon have been no slouches in that department either, with revenue growth of about 1,000% and 550%, respectively (the stock returns? Amazon’s up 2,170% and Alphabet 426% in the past 10 years… Facebook a little less than 400% in seven years since going public).
So who’s being teased as this “Data Refinery?” This is, still, good ol’ Splunk (SPLK), which was one of the early “crazy valuation” story stocks to come public in the early days of the “unicorn era” in venture capital, after the financial crisis, and has enjoyed the lift that “cloud” sector has gotten over the past few years. And while he does say this is his “most important tech stock of 2020,” I went through and double-checked everything, and all of the hints and clues he drops are the same ones he used when he called Splunk the “most important tech stock of 2019.” So that’s a sign of either laziness or consistency, depending on your perspective. (Some of what I’m writing here is also straight from my last article on Splunk, speaking of laziness…)
Incidentally, I noticed an interesting bit of trivia — since both companies went public in 2012, Splunk and Facebook have had almost identical revenue growth… though Facebook surged to profitability much more dramatically and has outpaced SPLK’s stock market returns, 460% to 346% (the time frame is not identical, to be fair).
Here’s how the company describes itself:
“Splunk was founded to pursue a disruptive new vision: make machine data accessible, usable and valuable to everyone. Machine data is one of the fastest growing and most pervasive segments of “big data”–generated by websites, applications, servers, networks, mobile devices and the like that organizations rely on every day. By monitoring and analyzing everything from customer clickstreams and transactions to network activity and call records–and more, Splunk turns machine data into valuable insights no matter what business you’re in. It’s what we call operational intelligence.”
Splunk has grown tremendously in the past seven years, revenue has gone from about $200 million in 2012 to $2.4 billion last year, but they are apparently not yet at the scale they envision as possible because they have continued to manage for growth, not profit, spending massively on SG&A and R&D.
They have posted losses averaging over $250 million a year since 2015 — though, thanks to the fact that employees are largely compensated with stock and they did a big debt offering in 2018 (about $2 billion), they should have plenty of cash to sustain the business at this rate for another few years without big equity offerings. The last secondary they did of any size was back in 2014, when they raised $540 million… but they’ve been sort of doing “shadow” stock offerings, over the past four years total stock-based compensation has been almost $2 billion (combined — last year’s was $545 million, 25% growth over the previous year), so instead of selling shares to raise cash to pay employees, they give employees shares in lieu of salary.
The magic of Silicon Valley accounting… which is illogical but hasn’t really been fought by investors for years. So the share count is rising, though some of that has been ameliorated over the years by stock buybacks (which is a great way to improve your cash flow and “adjusted income” numbers, by essentially pretending that employee compensation is a capital investment). This isn’t a Splunk-specific issue, of course, almost everybody does it and Splunk is not necessarily any worse than any of the other big fellas (Salesforce, etc.). To be clear, it has been a LONG time since investors cared enough about stock-based compensation to ding companies for their excesses, so it’s probably not worth overthinking that in the short term.
Major insiders have certainly been selling hand over fist, so presumably other employees have as well… after all, you can’t pay your rent in San Francisco with shares (average rent now just slightly below $4,000 a month, FYI, for a one bedroom apartment). Again, that’s not something that most tech companies get dinged for by investors, at least not while growth is continuing, but the insiders at SPLK don’t appear interested in ownership — it looks like they sell as soon as they can, and without regard to price, so they’re probably on automated selling plans, (they were selling early this year at $175 and selling even more at $122 during the March crash). Insider selling is not a clear negative for stock prices in the way that insider buying is a clear positive, but I find it’s always more reassuring to see an “ownership” mentality among managers.
If you’d like to get acquainted with Splunk, it’s worth browsing their website to learn what they offer to customers — it’s tough for those not in the business to really understand what data analytics and machine learning really mean (which is why King uses the term “Data Refining”), but it’s important to have at least some idea of what they actually do when you’re trying to figure out how they make money (or how they might make money someday, since they don’t today), and try to build an understanding of why you think the business can continue to grow or become more efficient as they grow.
My impression? I’d kinda like to work at Splunk, employees get a lot of equity… but more seriously, they are in a fairly clear (and so far successful) transition from “software sales” to cloud “subscriptions” for their data processing, which depresses current revenues but makes future revenues a little bit more predictable (their average customer is on something like a three-year contract).
That transition hit a hiccup, at least in the minds of investors, last summer — that was when they showed some signs of a little weakness in “bookings”, which made folks a little nervous but was forgiven after bookings recovered in the last couple quarters… and, perhaps more importantly, the transition from up-front sales to cloud subscriptions really hit cash flow — for the first time since going public, Splunk did not generate any free cash flow last fiscal year (which ended in January), probably mostly because moving to subscriptions means the cash comes in for a long period of time after contracts are signed, not up front as happens with enterprise software sales.
So the valuation of Splunk still gives me a headache, but they are growing really, really fast, and the forward bookings are strong thanks to those multi-year cloud subscriptions, which is what most investors care about most of the time. You can see the trends they want to focus on in their Investor Presentation from the last earnings call here… and investors have been pretty cheered this week by Splunk’s announced agreement to become available on Google Cloud (customers of the other two big cloud providers, Microsoft Azure and Amazon AWS, can already use Splunk to at least some degree, I don’t know if this Google integration is any easier or more direct).
Here’s they guidance that they were offering on their last call, in mid-March (transcript here):
“Looking forward, we are confident in the continued acceleration of customer adoption and high-growth trajectory, and we maintain our guidance for mid-40% ARR growth this year, fiscal ’21. Looking further out, we expect to sustain a 40% ARR CAGR through fiscal ’23 and we reaffirm our $1 billion operating cash flow target for FY ’23. Revenue guidance for this year is a little trickier, given the high variability that comes from cloud mix and related ratable revenue. With current expectations that cloud will contribute to a substantially higher proportion to overall bookings in fiscal ’21, it follows that revenue growth will flatten this year, even as software bookings and ARR continue at high growth rates. As we begin to benefit from the renewal of previously booked contracts in FY ’22 and ’23, revenue growth should rebound sharply.
“So, we expect total revenues in Q1 of about $450 million and full-year revenue of $2.6 billion and will follow our normal seasonal pattern of 40% front half and 60% in the back half. With anticipated revenue snapback starting in fiscal ’22, we expect annual revenue growth in the high-20% range in both FY ’22 and ’23. With this revenue trajectory, it follows that operating margin will trough in fiscal ’21 before rebounding at ’22 and ’23. We expect a negative 25% operating margin in Q1 and roughly breakeven for the full year and a long-term target of 20% by fiscal ’23. At our upcoming Analyst and Investor Meeting, we intend to provide a framework on how varying degrees of cloud mix will translate to revenue on profitability metrics over time, and we look forward to walking you through more details of this transition and our next phase of growth.”
That was on March 4, before the coronavirus “Great Cessation” hit the US and Europe (the US generates about 3/4 of Splunk’s business), and they did not at that time see any direct or immediate impact from the outbreak, though they did note that customers might start “circling the wagons” and being cautious, which they thought would probably be good for Splunk as a strong and established partner. I don’t think they’ve formally changed any of that guidance… but the fact that we’re in a big transition year (or two), as the migration to cloud and the “pause” that brings in topline growth continues, probably puts extra weight on this quarter, and on whether Splunk says anything new next week (they report on May 21) about the coronavirus impact on the business.
The positive thought for Splunk is that they are growing very fast despite the fact that they’re already pretty big, and the business is growing faster than the current top-line revenue growth indicates… and that they have ambitions to become a dramatically larger company to address an enormous market that is just emerging. If they are really able to hit their targets and generate $1 billion in free cash flow in 2023, with growth continuing to be in the 20%+ range, then a $25 billion valuation is steep but not unreasonable for the patient speculator.
And the negative thought is that you’re paying a helluva lot for the current business, given that they are nowhere near being sustainably profitable (GAAP-wise) and are unlikely to be so for years (at least)… and they’re still pretty early in this transition from software sales to cloud subscriptions, with no real guarantee that it’s going to work out as well as they are planning. So far it has been a huge success, beating their expectations, and the stock would probably be well above those February highs if it were not for the coronavirus concerns… but, of course, if a recession hits hard it could hit everybody.
Before the Google partnership news came out this week, there was some softness driven by analyst caution — here’s a quote from Briefing.com about the Cowen downgrade, which got the most attention at the time:
“Cowen downgraded Splunk (SPLK) to Market Perform from Outperform. Firm asserts that SPLK was already entering the year with a lot of business transition to absorb; add in COVID-19 related disruptions along with SPLK’s heavy reliance on large deals and high-touch engagements and they think risks to growth execution are more elevated than most.”
So no, to be clear, the stock has not been getting 30 “new” upgrades as King’s teaser implies — analysts are generally positive, with 30 buy or outperform ratings on the stock and only 11 “hold” or “sell” ratings, but those analysts also lowered their price targets pretty drastically during the coronavirus panic, so the average target for the shares now is right around $157… a few bucks below where the stock sits today. That doesn’t necessarily mean anything, of course, analysts aren’t any better at predicting where the market will go than you or I, but it does mean that, as with any growth stock, the next earnings report will be important — at these valuations, investors will very likely want to hear “beat and raise” language in the earnings call, analyst upgrades after the call, and some reassurance that the coronavirus recession is not having a massive impact on their long-term sales outlook.
And it’s probably worth noting that it’s only thanks to the crazy performance of so many cloud SaaS stocks and other “hot” tech stocks over the past few years that Splunk’s price/sales ratio of about 10X no longer sounds extreme — it used to be that 8-10X sales was a pretty steep price to pay even for a growth stock, but these days it sounds downright quaint (there are more than 25 large-cap tech stocks currently trading at a higher p/s ratio than Splunk, including other “cloud transition” firms like Adobe, Intuit, AutoDesk and others, as well as “cloud native” firms like WorkDay, Twilio, Slack, Okta and Atlassian).
They’re on the right trajectory, with the transition to cloud essentially complete now and likely to work its way through the income statement over a few years, so if this keeps up they will eventually become profitable and the efficiencies of scale should kick in within four or five years from now and generate some dramatic real earnings. It’s mostly a question of whether or not they’ll be able to hold off the competition… and carry this high valuation while we wait.
The biggest risk, other than a dramatic recession that slows ordering and keeps Splunk from signing on new customers, is probably competition in the “big data” processing space. And given the valuation, I should also note that the whole class of “super expensive cloud stocks” tends to trade together as investor sentiment waxes and wanes, so if that “risk appetite” disappears for a little while, Splunk and its near-peers will very likely fall more than the market, regardless of what’s happening at the company.
I’m cautiously optimistic, given Splunk’s strong success in transitioning to the subscription model over the past couple quarters, so I wouldn’t try to talk you out of nibbling on the shares, and I’ll hold on to the small 2021 call option position I have on SPLK through earnings (those options are essentially a “bet” that the stock will rise ~30% by January), but if I held a big equity stake I’d be a little bit nervous. Generally, when a high-impact earnings report is on the horizon for a stock you want to build into a long-term position, I think it’s sensible to split that purchase between “before” and “after” earnings rather than betting that the report will swing the stock up or down.
And that’s all I’ve got for you right now on King’s “most important tech stock of 2020” — it’s set up for a pretty volatile year or two, and the business is growing well at the moment, just don’t get your heart set on that 18,000% growth nonsense. Have a thought on Splunk you’d like to share? Just let us know with a comment below.
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Disclosure: I own shares and/or call options on Alphabet, Apple, Amazon, Splunk, Slack and Okta among the companies mentioned above. I will not trade in any covered stock for at least three days, per Stock Gumshoe’s trading rules.