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Business: Splunk is a leading provider of application software that collects and analyzes data from digital systems to help organizations identify security threats and monitor IT infrastructure. The company can take significant amounts of unstructured data from various systems and come up with insights that help alert IT teams to potential failures or breaches.
Stock Market Value: $13.9B ($85.67 per share)
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Percentage Ownership: nearly 5.0%
Average Cost: n/a
Activist Commentary: Starboard is a very successful activist investor and has extensive experience helping companies focus on operational efficiency and margin improvement. Starboard also has a successful track record in the information technology sector. In 48 prior engagements, it has a return of 34.45% versus 13.57% for the S&P 500 over the same period.
Starboard views Splunk as an opportunity to own a high quality and sticky business at an attractive valuation with the potential for significant value creation through a better balance of growth and profitability. Splunk’s software is mission critical for most companies, and it has a highly recurring business with approximately 22,000 customers, including 95 of the Fortune 100 companies. Splunk has a leading market share and is considered the “gold standard” in the log management and security markets.
Over the past several years, Splunk has been undergoing a complex business transition. The company has been going from a perpetual license to subscription-based model, leading to negative free cash flow as they transitioned to an annual invoicing model in 2019. It is near the end of this transition. In 2022, it began generating positive free cash flow for the first time since the transition began.
This is a typical Starboard investment – a company with strong top-line growth and enviable market position that needs help with optimizing growth and margins. Often this requires a change in management. Well, good news for Starboard and other shareholders: This is already happening.
In November 2021, CEO Doug Merritt stepped down. In March 2022, Splunk announced it would appoint Gary Steele, founding CEO of Proofpoint, to the helm. Splunk is now searching for a new CFO. Steele has a history of operational execution. In August 2021, Thoma Bravo bought Proofpoint at all-time high prices. Starboard believes that there is significant opportunity for the new management team to improve operational performance.
Technology companies like this are generally compared on a growth plus profitability metric. Splunk currently has a 17% growth rate and an 11% operating margin, giving it a combined 28, versus a peer median of 47. Starboard believes that Splunk’s operating margins can get to at least 30% (peers are currently at 26%) and revenue growth can exceed 20% (peers are at 21%), which would put it right up there with the peer median. Starboard believes that achieving this could double the company’s valuation.
With a new management team, it is not as urgent that Starboard get board seats right away. They will likely work with Splunk as an active shareholder. If they do go on the board in the short term, it will be because the company invites them on after seeing how valuable Starboard can be and has been in situations like this. If this does not happen by Feb. 16 — when the shareholder director nomination window opens — and there is no marked improvement in operations, we will likely see Starboard make director nominations.
While this is clearly an operational engagement for Starboard, it must be noted that there is another opportunity to create shareholder value here. When an activist takes a position at a company, it puts that company in pseudo-play with potential acquirers often coming out of the woodwork. It is possible that something like that could happen here. In February, when Splunk had an $18.4 billion market cap, the Wall Street Journal reported that Cisco made a $20-plus billion offer to acquire the company. You would think that their interest level has piqued a little with Splunk now trading at a $12.7 billion market cap.
Ken Squire is the founder and president of 13D Monitor, an institutional research service on shareholder activism, and he is the founder and portfolio manager of the 13D Activist Fund, a mutual fund that invests in a portfolio of activist 13D investments. Squire is also the creator of the AESG™ investment category, an activist investment style focused on improving ESG practices of portfolio companies.