Splunk Investors Still in a Funk Despite Strong Revenue Growth

NEW YORK (TheStreet) – Splunk (SPLK) investors were desperate for some good news ahead of the company's fiscal second-quarter earnings report last week. Splunk didn't disappoint.

Helped by a 52% year-over-year surge in revenue, the San Fransisco-based big data company delivered a solid beat, which sent the stock soaring almost 20%.

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Shares are now around $57, closing Wednesday down almost 5% and giving back a meaningful portion of last week's gains. 
As it stands, Splunk investors are still in the hole by roughly 17% in 2014.With larger players like IBM (IBM) and Hewlett-Packard (HPQ) positioning for Big Data dominance, Splunk's second-quarter victory, while inspiring, may be short-lived.

An email sent to Splunk requesting clarity on the company's growth metrics and forecasts was not immediately returned.

The market seems divided on where the company is heading next.

Gregg Moskowitz, analyst at Cowen & Co., is bullish. Following the report Moskowitz reiterated his outperform rating and raised his price target to from $55 to $60. In his research note to investors, Moskowitz said,

"Splunk is extremely well positioned to capitalize on Big Data, and the use cases continue to grow steadily, in turn expanding the addressable market.”

To justify his bullishness, Moskowitz upped his full-year revenue forecast by 4.5% to $426.6 million and now believes Splunk can earn a profit of 2 cents per share ahead of his prior target of breakeven.

At the same time, however, Richard Davis of Canaccord Genuity cut his price target by more than 14%. Although Davis' new price target of $60 (from $70) represents an 11% premium, Davis raises a great point regarding -- what he calls -- "multiple compression." This is when a stock price fails to move upward (and may go down) despite strong earnings.

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In the case of Splunk, the shares are too expensive, even with the year-to-date decline. Consider that at around $56 per share the stock is trading at a price-to-earnings ratio of negative 86, according to Nasdaq.com. Based on next year's estimates of a loss of $1.48 per share, the P/E is still at a negative 40.

So where's the value?

Morgan Stanley's Keith Weiss, who has an equal weight rating on the stock, raised the same argument. While noting that the shares are "pricey," Weiss reminded investors that the competition has not gone away.

What's more, management, which hinted about potential price targets, did little to alleviate concerns about margin pressure. While undercutting larger players like Oracle (ORCL) and SAP (SAP) may help grow the top line, it doesn't help the company from the standpoint of earnings and cash flow growth, which is assumed by the already high multiple.

In other words, while the accelerated growth rate may be impressive, Splunk's spending and operating expenses are also on the rise. This resulted in a loss of $60.8 million compared to a year-ago loss of $13.7 million.

The other thing is, while analysts are gushing over the company's 37% jump in license bookings and strong gross margins of 85.2%, this is still a 370-basis point drop year over year. This means that the overall license business, which has a gross margin of close to 100%, is now growing slower than expected.

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There's no denying that Splunk, like most young companies, continues to be an incredible growth story. That, however, does not alleviate valuation concerns, especially with the company lacking in pricing leverage. For now, until there are clearer signs of competitive leverage, it's best to stay away from these shares or until the stock drops to $40, an area where the risk is more palatable.

At the time of publication, the author held no positions in any of the stocks mentioned, although positions may change at any time.

Follow @Richard_WSPB

This article is commentary by an independent contributor, separate from TheStreet's regular news coverage.

TheStreet Ratings team rates SPLUNK INC as a Sell with a ratings score of D. TheStreet Ratings Team has this to say about their recommendation:

"We rate SPLUNK INC (SPLK) a SELL. This is driven by a few notable weaknesses, which we believe should have a greater impact than any strengths, and could make it more difficult for investors to achieve positive results compared to most of the stocks we cover. The company's weaknesses can be seen in multiple areas, such as its deteriorating net income, disappointing return on equity, generally disappointing historical performance in the stock itself and feeble growth in its earnings per share." You can view the full analysis from the report here: SPLK Ratings Report

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