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By Rodney Nelson | 10-17-2017 09:00 AM

Splunk Is No Longer Just a Pesky Upstart

The firm has a long runway for growth, and we assign it a positive moat-trend rating.

Thanks to its versatile software, Splunk has evolved from a pesky upstart to a legitimate threat to legacy data analysis software vendors. Enterprises are increasingly turning to Splunk to handle a multitude of use cases, from application monitoring to security, providing a long runway for growth.

Splunk's robust, customizable software platform is built on machine log analysis. Its products provide insights into how users are behaving within the IT infrastructure, and how customers are interacting with the company, all in real time.

Splunk has a number of key tailwinds behind it, including the burgeoning "Internet of Things" that will help drive data growth of roughly 40% annually through 2020. Despite its growing footprint, we do not believe Splunk has yet earned an economic moat. The company still faces heavily entrenched competitors in IBM, SAP, and others. Further, the company is unprofitable, spending more than 70% of its revenue on its salesforce, which is an abnormally high rate for a company of its size. This high spend has deflated returns on invested capital in recent years.

We do, however, assign Splunk a positive moat-trend rating. Retention rates have risen consistently over the past several years, and use-case expansion has yielded larger average sale prices during that period. That has led to increasing customer switching costs for the company. We'll be watching for signs of substantial operating leverage, which we would expect to see in a moaty software company.

Shares of Splunk currently trade about 10% below our fair value estimate. Given the high uncertainty rating on the stock, we suggest investors wait for a wider margin of safety before investing.

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