Good Morning!

After 3 consecutive washes of getting my blanket into my duvet cover in less than 10 minutes, I sadly have to share that the streak is broken and broken badly. 

15 minutes in, I found myself trapped in the darkness of the duvet cover stressed, angry, and with no immediate progress in sight. Wish me luck tomorrow as I give it another go. 

On a less serious note (sarcasm I think), I posted on Linkedin a few days ago with some thoughts on Warren Buffett’s Annual Report from 1997 and some of his simple yet brilliant insights. Make sure to check it out here.

FYI - we will be taking next week off due to Christmas. Have a Merry Christmas everyone and enjoy the time with family and friends. That is what it is all about.

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DEEP DIVE

Overview

Splunk is a software platform used to monitor, search, analyze, and visualize a company’s data in real time. 

The software platform takes all of a company’s data from the various inputs throughout the company that enables employees at a company to interact, share, and take action from the data trove. 

Splunk has 3 key products that include: 

• Splunk Platform – search and visualization and business analytics
• Splunk Security – event management and user and entity behavior analytics 
• Splunk Observability – application and infrastructure observability 

All 3 of these industries represent a ~$100B TAM. 

To try and form a thesis around Splunk, it is integral to understand the transformation that the company is going through from a product offering perspective.

Historically, Splunk’s core offering was an on premise product licensing model. In 2016, the company embarked on a journey to create a cloud offering to align themselves more with the future and benefit from the speed, cost effectiveness, and integration powers that the cloud offers. 

After a difficult transition period which saw the company fall to -5% and 20% revenue growth in 2021 and 2022 vs. growth of 38% and 31% in 2019 and 2020, the results are paying off and Splunk is roaring back. 

That was my brief finance degree level analysis on the technical side of Splunk. I know. Incredibly impressive. For a more technical overview, check out this Substack writeup by Rak Garg. 

Traction

For Fiscal 2023, the company expects to return to ~30% growth and revenue ~$3.485B vs. $2.674B of revenue in 2022. The company has achieved this growth by not only unlocking significant cloud performance, but also by growing spend on the legacy product.

Specifically, Splunk is rocking a DBNER of 127% for the cloud offering which shows significant momentum.

Interestingly, this DBNER represents a 3% YoY drop in DBNER in the cloud, but the great and accomplished Gary Steele, CEO of Splunk, shared that this is due to companies bunkering down due to the macro environment. Steele remains confident that companies will want to continue to move to the cloud in the long run.

Splunk also has a very diverse revenue base as there were 754 customers with more than $1M in ARR in Q3 ‘23 vs. 635 in ‘22. Also, customers with over $1M in ARR on the cloud was 380 vs. 270 last year. 

Quick tangent – I am a big believer in businesses that have a legacy offering as well as a cutting edge, next gen technology offering. Change is inevitable yet often occurs slower than everyone thinks. 

Several of The Crossover Portfolio investments are companies that share these tenants: 

• Paramount: LinearTV and Streaming
• Callaway: Callaway and TopGolf
• Penn: Land Casinos and online sportsbooks/Barstool

When executed properly, this gives companies the ability to build off of their core competencies, grow wallet share of the customer, and achieve significant cost cutting/efficiencies (something that we will touch on later with Splunk) all while growing the pie.

Free Cash Flow

But what excites me the most about this opportunity are three of my favorite words in the human dictionary when put together: Free Cash Flow. 

There has been serious FCF growth at the company, and I think the potential of just how high this figure can get is not getting the respect it deserves. 

As you can see below, the company expects more than $420M in FCF this year – a raise from the prior guided mark of $400M. After ‘20 and ‘21 saw years of significant investment in the push to the cloud, it appears that investment is paying off.

The company has and will continue to achieve this FCF growth not only from top line revenue growth, but also expense reduction across hiring, real estate, contingent labor, and traveling expenses. Specifically, the company consolidated from two buildings in San Francisco to one netting them $15M in savings. 

Additionally, Steele shared that he sees significantly more runway for costs to come down and not only will it not hurt the company's growth aspirations, but could help. Here is the direct quote: 

“Yeah. I do not think at all that we're inhibiting our ability to grow with the cost initiatives that we put in place. And I actually believe what we're doing is creating a more efficient business that can scale more effectively, that can better deliver for our customers. So, I do not believe anything that we're doing is inhibiting our ability for the business to grow.”

Love. It. 

With a market cap of $15B, Splunk is trading ~35x FCF which does sound expensive, but what if the cost cutting and growth continues leading to $500-600M in FCF in 2024? 

What if that trend continues and a few years from now this company is cranking $1B in FCF? I don't think that is out of the question. 

Then 35x today is not that big of a deal. 

The Crossover portfolio picked up $40K of Splunk. We would like to add more to this position, but due to the fact that the valuation is a little high, we did not go harder (like we did with $DOCN). Also, I would love to spend more time continuing to learn about the offering from a technical perspective. 

Another aspect to my bullish thesis? 

The investors behind the company and the CEO.

Institutional Investors & Gary Steele

The M&A activity in the B2B Saas/Tech space will be off the charts in the next 12-18 months and private equity will be a big reason why. Our friends Thoma Bravo have been leading the way with their acquisitions of SailPoint, ForgeRock, Ping, and most recently this past week Coup Software. They will also not be stopping soon as they announced a $32B fund a couple weeks ago. 

What do private equity and Alan have in common? Not peacoats.

Good guess as I have a beautiful one, but don’t rock it enough, but rather our passion for cost cutting, profit generation, and a whole lot of FCF.

Where private equity goes, I like to go and as you might have guessed private equity likes Splunk. 

Specifically, H&F Corporate Investors, the $90B+ San Fran PE fund, made a $1.38B investment into Splunk on March 4, 2022 @ ~$115 a share representing a 7.5% stake in the company . On September 10th 2022, H&F grew their holding to 7.9% of the company with the stock ~$90 a share. 

Not only did H&F increase their stake in the company, but they also entered into a “standstill agreement” that gave H&F access to confidential Splunk information and that Splunk would not enter into any proxy contest.  

TL;DR – H&F is serious about Splunk. 

Another thing to consider when it comes to Splunk is their new CEO Gary Steele. On March 2, 2022 Steele become the new CEO of Splunk bringing over 30 years of significant SaaS executive experience and success. 

Steele was the founder and CEO of Proofpoint, an American enterprise security company, which he led not only to a ~$400M IPO in 2012, but then grew the company over the next decade leading to a $12.3B acquisition by Thoma Bravo in 2021. 

Steele not only has an extraordinary track record of success as an operator, but also doing so while creating an incredible amount of shareholder value – and getting a deal done with private equity too. 

Steele knows how to make it happen, and I not only think that he will ensure the continued success and development of Splunk’s platform, but will also cut costs and get this thing ready to be acquired over the next couple of years. 

Prediction: Splunk will be acquired in late 2023 early 2024, and if they are not acquired, it because the stock is approaching $175-$200 a share.  

THE CROSSOVER ARCHIVE

Missed a recent edition? That's okay! Now you can just click on these links below to catch up on what you missed!

• 12/09 - Public: FinTech's Next Star
• 12/02 - Core Four: Build-A-Bear, a16z, Apple, Wander
• 11/29 - Paramount Global: The Rollercoaster Continues
• 11/27 - Mitchell Green - Still a Crossover Legend

CHARTS OF THE WEEK

PORTFOLIO

Note: The Crossover Portfolio is a mock portfolio of how I would be investing and not with real money. All trades are shared publicly @ The Crossover Twitter as they are recognized. 

• In the Crossover Portfolio section today, we will be focusing on some of The Crossover Private Portfolio Investments who have been on fire. 
• RocketVR - RocketVR, the digital therapeutic VR company, was named a Top 150 Digital Health company by CB Insights. Congrats to Sid & Nik on this exciting news. Click here to see my writeup and interview on the company. Also, they might still have a little room left in their round so let me know if you are interested, and I can make an introduction. 
• The Zone - The Zone, the mental wellness platform for student athletes, completed their Talent & Opportunity accelerator with a16z with a demo day that Ivan crushed. The company also tied for first place (out of 30 companies) in the Columbia University Care One Healthcare Challenge netting them $12,500 in cash prizes. 
• SEQL - SEQL, the equalizer in the sports equality space, announced that they have launched a show on Snapchat called Hidden Gems featuring high school athletes highlights. This represents not only a revenue opportunity for SEQL, but great for brand awareness. 

What. A. Week. 

VENTURE CAPITAL

Battery Ventures released their state of the 2022 OpenCloud Report, and it was sweet. There are two ways to check it out: 

1. Powerpoint: Click here
2. Video: Click here

I would recommend checking out the video as General Partner Dharmesh Thakker walks through the key findings. 

Here are some key takeaways from the report: 

• A pretty direct correlation between decrease in multiples and rise in interest rates as an industry NTM revenue is expected to grow ~21% which is just a couple percentage points lower from way back in 2018 yet multiples are down

• Even in the current macro environment, cloud vendors continue to grow nicely as the annualized run rate of cloud vendors increased from $116B in Q2 '21 to $159B in Q2 '22. AWS owned about 50% of the market followed by Azure ~33% followed by Google Cloud ~16%. The other couple of percent of spend were with Snowflake and DataBricks (on top of the cloud)

• Stock based compensation is a real expense for many highflying cloud names led by Confluent (8%), PagerDuty (5%), Cloudflare (5%), MongoDB (4%). The average is around 4%. 

The report is awesome, and I highly recommend checking it out. I also put together a tweet highlighting my four favorite charts. 

MEDIA MUSINGS

The Rundown: nScreen Media hooked us up with an overview of the number of households that have all the various mediums of entertainment that you see above at the end of Q3 (out of 128.3M)

 Key Takeaways:

• The US Pay TV ecosystem lost another 6.6M households vs. 5.6M in the same period last year and is penetrated in 53.2% of households vs. 88% 9 years ago. 
• SVOD penetration declined from a total household percentage to 82%, but nScreen says this number will hover in the 80-85% range. Interestingly, the average amount of services per household increased.
• vMPVDs (YouTubeTV, Hulu Live TV) grew to 14.5M households representing grew 22% YoY. While classic Pay TV lost 6.6M, vMPVD gained 2.6M (40% of cord cutters picked up a vMPVD)
• FAST (PlutoTV, Tubi) is now in 24% of households representing 36% growth YoY. The FAST space is expected to do $4.1B this year, representing ~100% YoY growth.

Alan's Angle:

I always love overviews like this especially when it keeps things nice and simple. The most intriguing thing to me in all of these charts is the power of vMPVDs and just how much it offsets the losses of classic PayTV. 14.5M is a real number and fueled by the power of Google/YouTube, I anticipate that the space will continue to grow nicely - which is specifically beneficial to companies that benefit from the bundle like Paramount, WBD, Fox, Disney. All of these companies have incentives to see the bundle stick around for a long time, and therefore I think it will. 

I continue to believe that the pie will be bigger for the legacy/streaming entertainment landscape with the mixture of vMPVD/MPVD + AVOD + SVOD + FAST which will ultimately lead to significant profit for those that can achieve success in this domain. 

I also think this is specifically good for our portfolio pick Paramount who is a beneficiary from the bundle, has the fastest growing AVOD/SVOD offering in Paramount+, and the #1 FAST offering. Cutting costs across the company, achieving synergies, and being able to amortize content on a global basis gives me confidence in Bakish and Shari's game plan - especially at this valuation. 

MEMES OF THE DAY

GOLDEN NUGGETS

• Carmelo Anthony and Lebron's sons playing against each other in high school basketball is too cool. And it makes me feel old!
• RIP Grant Whal. A legend gone too soon. 
• The alcoholic seltzer market has seen a serious decrease in sales! Why do you think that is?
• Actual footage of your dad when you get back home from a 2 week vacation and you both realize you left your light on
• Really enjoyed this conversation between Rich Greenfield and Marc DeBevoise on the state of streaming and the creator economy

Thanks for the read! Let me know what you thought by replying back to this email.

— Alan 

Disclaimer: The Crossover is not a professional financial service. All materials released from The Crossover are for educational and entertainment purposes. The Crossover is not a replacement for a professional's opinion. Contributors to the Crossover might have positions in the equities in the The Crossover Portfolio or mentioned in the newsletter.

Written by me, Alan Soclof.

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