Going Big

The Stock

The Trade: Splunk (NSDQ: SPLK)–Buy < 32.

Why Now: This play on Big Data has pulled back with the broader market, presenting investors with an ideal entry point.

The Story

Home after a day of sailing in Annapolis, Md., Elliott sits at his desk and pours a glass of ice-cold Puligny-Montrachet. With drink in hand, Elliott calls Yiannis to discuss Cocktail Stocks.

Yiannis: Ne? What’s up? I called you all morning, but you never picked up.

Elliott: A “land hurricane” blew through the DC area last night, causing widespread power outages. The storm also took out a bunch of mobile telephone towers, so service has been spotty. Fortunately, my house never lost power.

Yiannis: You should join me in Mykonos. Everyone wants to know when you plan to visit.

Elliott: I’ll try to make it over later this summer. Today I sailed on a 36-foot boat in the Chesapeake Bay. My sailing skills have improved immensely since I chartered that boat in the Caribbean; soon I’ll be ready for the Aegean.

Yiannis: The Aegean is tough–definitely less forgiving than the Chesapeake Bay.

Elliott:  Kind of like Greek politics?

Yiannis: Easy there. We elected a pro-bailout government, and the recently announced plan to expand the scope of the European Stability Mechanism has sent equity markets higher. Speaking of which, what do you think about our short plays in Netflix (NSDQ: NFLX) and Best Buy (NYSE: BBY)?

Elliott: I’m not too worried about these bets because the recent rally overlooks a number of headwinds. For example, US economic data continues to soften. Recent regional manufacturing surveys have disappointed, suggesting that the Institute for Supply Management’s purchasing managers index could come in at less than 50, the dividing line between expansion and contraction.

Nonfarm payrolls data have also weakened, and I wouldn’t be surprised if employment numbers disappoint next week. And don’t forget the uncertainty surrounding the tax hikes and spending cuts that are slated to occur shortly after the US presidential election.

Yiannis: What about Best Buy? The business continues to flounder, but I’ve heard rumors of a possible takeover.

Elliott: Richard Schulze, the founder and former CEO of Best Buy, reportedly has talked to bankers about taking the company private. Shares of the embattled retailer enjoyed an intraday pop on the day the rumor hit the newswire but sold off dramatically by the end of the trading session. The stock’s recent strength stems from the rally in the broader market, not an improvement in the underlying business, which remain under pressure.

Yiannis: I agree with your assessment. The stock would need to drift substantially lower to become a legitimate takeover target.

Elliott: You have any ideas for this month’s pick?

Yiannis: Come on, man. I’m at the beach. That email you sent me indicated that you had something in mind.

Elliott: Although I expect the S&P 500 to at least re-test its summer low in the next few months, a handful of names on my watch list look like good buys before the market rallies at year-end.

Yiannis: So what’s your big idea?

Elliott: Splunk (NSDQ: SPLK).

Yiannis: What? Does the company specialize in cave-diving tours?

Elliott: You’re thinking of spelunking, man. Learn the language. Splunk specializes in “Big Data,” or the collection, sorting and analysis of enormous amounts of data to glean useful information on customer behavior or business inefficiencies and bottlenecks.

Yiannis: That’s not as interesting a business as cave-diving, but it’s probably more lucrative. Tell me more.

Elliott: Big Data is one of the fastest-growing trends in the technology sector, and investors are keen to add exposure to the space; Splunk’s shares surged 109 percent on their first day of trading.

Yiannis: I’m familiar with Big Data. We’ve written about this trend at length in Personal Finance, though those articles have focused primarily on the hardware that’s enabled this revolution.

Elliott: Big Data is huge. Consulting firm International Data Corp (IDC) estimates that in 2011 the volume of digital data collected globally reached 1.8 trillion gigabytes. The US Library of Congress in Washington, DC, has accumulated about 240,640 terabytes of data since its founding. In other words, the amount of digital data collected globally in 2011 equals almost 7.5 million Libraries of Congress. IDC estimates that by 2015 companies will gather 7.9 trillion gigabytes annually, implying an average annual growth rate of 45 percent.

Yiannis: The mind swims at the enormity.

Elliott: Some of the data that companies collect is structured and stored in orderly databases. For example, an online retailer might hold a customer’s name, record of past purchases and a credit card number in a database format that can be easily accessed.

The quantity of unstructured data is far greater. For example, users post more than 30 billion individual pieces of content to Facebook each month. With each minute that passes, 20 hours of video are posted to YouTube.

Many retailers also have weblogs that track what items customers add to their online shopping cart and how long they linger on a particular product description deciding whether to buy the item.

Let’s not forget about data generated on the mobile web. Modern smartphones contain global positioning satellite (GPS) chips, which, if enabled by the user, transmit data about the consumer’s location during certain activities. Some firms are experimenting with location-specific marketing. Imagine, for example, walking by a store and receiving a coupon on your mobile phone for a special discount.

Yiannis: Big Brother is watching.

Elliott: Until recently, analyzing unstructured data in real time and using this information effectively was a challenge. Splunk’s software collects, indexes, searches and analyzes vast quantities of unstructured data–up to several terabytes per day for one firm. Customers pay a licensing fee based on the estimated amount of data they need to index and analyze. This billing arrangement means that Splunk benefits directly from growth in the amount of data that companies collect and store.

Yiannis: Sounds as though Splunk is in the early stages of its growth story.

Elliott: At the end of January 2012, the firm had 3,700 customers, including the majority of the companies in the Fortune 100. A year ago Splunk had 2,300 customers. The firm’s revenue has surged to $121 million in its 2012 fiscal year from $35 million in its 2010 fiscal year.

This rapid growth hasn’t slowed. In its first quarter as a public company, Splunk’s sales soared 81 percent on a year-over-year basis, to about $37 million. These revenue figures trounced analysts’ consensus estimate of about $33.5 million. Management also called for full-year sales to range between $174 and $177 million.

Although the company has yet to turn a profit, that’s not unusual at this early stage.

Yiannis: I like the story, but what about the stock’s valuation?

Elliott: Even after the recent pullback, the stock trades at 16 times the high end of management’s full-year revenue guidance. This lofty valuation reflects the firm’s growth potential, as well as a scarcity premium; the stock is the first pure play on Big Data to go public.

With the scope to grow sales at an average annual pace of 80 percent over the next few years, Splunk’s long-term growth potential warrants a hefty valuation. Shares of Google (NSDQ: GOOG) traded at more than 20 times the company’s full-year 2003 revenue at the close of the stock’s first day of trading in 2004. Despite what many pundits regarded as an insane valuation,Google ranks as one of the most successful initial public offerings of all time.

Yiannis: The siren song of the sea is calling me back.

Elliott: That sounds like your wife nagging you.

Yiannis: No comment. What’s your buy target?

Elliott: Splunk is a speculative stock for investors who can stomach the volatility. Buy Splunk under 32.  

Updates on Open Trades

August 2010: Vale (NYSE: VALE)–Buy < 25

Iron ore prices have held up thus far, but expectations of slowing economic growth in China have weighed on shares of Vale. Nevertheless, the Brazil-based mining giant’s long-term growth story remains intact, though iron ore prices will drive the stock in the near term.

September 2010: Teekay Tankers (NYSE: TNK)–Buy < 7

A 14.5 percent yield is Teekay Tankers’ only saving grace. We have been in this trade long enough that all the bad news has been priced into the stock–including lower day-rates on the spot market. The stock has gained ground but has a way to go for us to break even.

February 2011: ProShares UltraShort 20+ Year Treasury (NYSE: TBT)–Buy < 25

Betting against US Treasury notes has been a losing proposition. This position could recover some lost ground when investors rotate funds from safe havens to equities.

June 2011: iShares MSCI Italy Index (NYSE: EWI)–Buy < 15

This play on Europe’s turnaround is less risky than our Greece-related bet. The recent plan to expand the purview of the European Stability Mechanism should reduce the Italian government’s borrowing costs. The exchange-traded fund also offers a 5.5 percent dividend yield.

July 2011: TransGlobe Energy Corp (NSDQ: TGA)–Buy < 15

Shares of this small-cap oil producer have posted solid gains in 2012, though the stock has pulled back because of retreating oil prices. This speculative stock will outperform in bull markets and underperform in bear markets.

July 2011: Market Vectors Gulf States Index (NYSE: MES)–Buy < 23.50

This exchange-traded fund (ETF) has held its own since we featured it in July. We’re holding out for a powerful upsurge.

August 2011: National Bank of Greece (NYSE: NBG)–Buy < USD3

This stock is our most speculative play to date and is only appropriate for aggressive investors who can stomach a bet that’s based solely on a turnaround in Greece. Any orderly resolution to Greece’s sovereign-debt crisis could send the stock price higher in a hurry. The outcome of the Greek election has helped the stock.

September 2011: China Cord Blood Corp (NYSE: CO)–Buy < 4

Don’t let near-term volatility shake you out of this stock. Private-equity firm KKR recently purchased $65 million in convertible notes issued by China Cord Blood. Expect more upside as the industry’s fundamentals turn.

October 2011: Infosys (NSDQ: INFY)–Buy < 50

A slower mover than other technology stocks, shares of Infosys should keep pace with India’s stock market, which has been pounded this year. Investors should only add to their positions when the stock trades at less than 50.

December 2011: Symantec Corp (NSDQ: SYMC)–Buy < 18

Internet security is a major growth market. The stock appears to have found support at current levels.

February 2012: Greenbrier Companies (NYSE: GBX)–Buy < 20

This stock has sold off since we profiled it in February, but the company’s underlying growth story remains intact. Better economic numbers in the US will support the shares.

March 2012: Best Buy (NYSE: BBY)–Sell Short > 17.50

We doubt the CEO change will enable the retailer to combat secular headwinds. The stock has bounced of late, but we expect further downside. Stay short.

April 2012: AU Optronics (NYSE: AUO)–Buy < 5

The stock has pulled back with the broader market. Rising LCD panel prices will help. If demand keeps up, we may see shortages of panels by September. AU Optronics remains a turnaround play with solid upside.

May 2012: Roundy’s (NYSE: RNDY)–Buy < 12.50

Management indicated that 2012 sales growth would be lower than expected, and the market sold the stock. At the same time, the initiation of a quarterly dividend could offset some of this weakness.

June 2012: Netflix (NSDQ: NFLX) Sell Short > 60

The stock has been dragged higher by recent rebound in the broader market, but fundamentals remain bearish and this mini-rally looks like a good opportunity to jump in on the short side.

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