Splunk Is A Rare Tech Growth Opportunity For 2023 (NASDAQ:SPLK)

As the tough bear market of 2022 comes to a close, investors need to look deeper than yesterday’s big tech winners. High valuations are now hard to attain, and a company needs to see real organic growth to shake off the bearish market sentiment. Splunk (NASDAQ:SPLK) is one company that can evade a recession and reward investors in 2023 and I will dig deeper into the key trends in this article.

Splunk rises on raised 2023 management outlook

Splunk rallied earlier this month after management raised its 2023 guidance in the third-quarter results.

In addition to our strong top-line results, we also made good progress on our expense reduction during the quarter. As a result, we are increasing our full-year outlook for total revenues, profitability, and free cash flow – Splunk President and CEO Gary Steele.

Top-line highlights in the Q3 report saw total revenues up 40% to $930 million year-over-year, while cloud revenue grew 54% to $374 million year-over-year. On the bottom line, EPS came in at $0.83, compared to -$0.37 a year ago, beating the $0.25 predicted by analysts.

Despite a tough environment for business spending, Splunk was able to deliver a cloud dollar-based net retention rate of 127%. That will provide a safety net for revenue growth in the current macro environment and would also be a platform for a recovery scenario in tech spending.

Other positive news earlier this month saw the company sign a five-year extension of its Strategic Collaboration Agreement with Amazon Web Services.

Splunk has additional takeover value

Another supportive dynamic in the gloomy economic backdrop is a potential takeover of Splunk. Needham analyst Mike Cikos said back in October that a bid for Splunk seems “more likely than not,” after it was reported that activist investor Starboard Value took a near 5% stake in the company. Per Cikos:

Investors we have spoken with this year have increasingly viewed a buyout of Splunk as a binary event. We believe the volume of potential buyout candidates and activist investor agitation indicates a deal is likely. Separately, we view Mr. Smith’s expected conference presentation and discussion on Splunk as rallying support for a takeout.

Splunk traded at a high of around $225 in October 2021 but now trades at only $86. February 2022 also brought a WSJ report that Cisco (CSCO) had made a $20bn takeover offer for Splunk, which would be a company record and well beyond its previous $7bn acquisition of Scientific Atlanta. The companies were said to not be in active discussions and the bear market that got underway with the Ukraine war later that month likely put paid to any deal.

With a current market capitalization of $14bn, analysts have placed a price of $120-130 per share for the company- a return of 45% on the current stock price.

Valuation and margins support a strong year ahead

The valuation picture for Splunk is promising with a price-to-sales ratio of 4.27 which is extremely low for a stock with growth potential. A forward price-to-earnings ratio of 34.5 is also a good investment level for a stock that produced quarterly sales growth of 40% in a tough business environment.

The company is also turning a corner on margins and the bear market in tech with the associated cost-cutting across the board has been a blessing for Splunk. Gross margins are 75% and pointing higher while operating and net margins have jumped to -20% with a similar uptrend in place.

That metric could ultimately drive stronger valuations in the coming year. The price-to-free cash flow metric is 47x at the present moment but if the company delivers on its prediction for a near 4x improvement in cash flow then that metric gets slashed.

Another cushion for the company to ride out the bear market and possible recession is an average contract length of around two years.

Quarterly cloud revenue is showing signs of slowing but the picture shows a long runway before it has a material effect and many technology growth firms are in a much more drastic situation.

The market for cloud computing will also continue to grow in 2023 with Microsoft saying in its 2023 outlook:

Macroeconomists may be pessimistic about gross domestic product growth in Europe and the United States in 2023, but even in weak macroeconomic scenarios, cloud growth rates remain stellar.1 Gartner predicts almost 30 percent growth for infrastructure as a service and almost 25 percent growth for platform-as-a-service in 2023, as compared to 2022 in the worldwide public cloud user spending category.

Gartner predicts that by 2025 more than 90 percent of clients will use cloud-based unified endpoint management [UEM] tools, up from 50 percent in 2022.

That gives Splunk a very strong position for growth over the next two years and it is well-positioned to deliver gains for investors, starting in 2023.

Risks to the bullish Splunk thesis

In reality, it is hard to see any material risk to the company in the coming year. Strong retention of clients and improving metrics will support the stock price. In the event that the technology sector sees another sharp sell-off then Splunk gets even cheaper. We also have the safety net of a potential takeover bid which would reduce any downside activity.

Microsoft’s management predictions for 2023 also said:

A September 2022 survey of chief technology officers by Evercore-ISI asked the top things they would do in response to reduced budgets or inflationary pressure. The top answer (from 44 percent of CTOs): increase their use of the cloud.

Splunk looks to be a rare technology stock in 2023 that can stride forward powerfully and position itself for future growth due to its recent cost-cutting measures.

Conclusion

In a tough year for technology stocks, Splunk looks to be a diamond in the rough for investors in 2023. The company saw strong revenue and cloud growth in its Q3 earnings, and although cloud revenue growth is slowing, it is still above 60% on a quarterly basis, with expectations of 54% in Q3 2023. The potential for a takeover bid can shield the stock from any further technology selling but this looks to be one that investors have gotten wrong. With a rapidly improving margin picture and strong customer retention, Splunk should deliver for investors in 2023.

Editor’s Note: This article was submitted as part of Seeking Alpha’s Top 2023 Pick competition, which runs through December 25. This competition is open to all users and contributors; click here to find out more and submit your article today!