In another indication that the market for technology transactions is gathering steam, Cisco announced last month its intention to buy Splunk for $28 billion. The networking company is spending a nontrivial fraction of its market capitalization on the transaction, and while Splunk shareholders are cheering the deal and the premium it may bring to their own holdings, Cisco’s shareholders appear to be less enthused, if the stock price is any indication.
In strategic terms, the deal is being hailed as a big win for both teams, bringing together AI and data management capabilities, especially as applied to cybersecurity of Splunk with Cisco’s network data. Together they have the potential to be a powerful combination, but bringing together two large companies like this is no small task, and the ability to merge two cultures will go a long way in measuring the success of the deal.
In financial terms, it’s interesting. While the recent Klaviyo IPO gave us a look at how the market values high-growth software companies as they go public, the Cisco-Splunk deal instead shows us the potential value of slower-growing software entities. Thus the transaction is slightly less meaningful for startups than this week’s public offerings, but still useful given the sheer dearth of liquidity events that we have seen lately.
Now, as the announcement hype has faded and as reality sets in, it looks as though Cisco investors still aren’t necessarily thrilled about the deal. Maybe the big price tag is scaring them, but they haven’t answered enthusiastically, that’s for sure. The question is: Why?
Can they come together without Cisco killing it?
One thing Cisco has going for it, according to Ray Wang, founder and principal analyst at Constellation Research, is a track record of absorbing acquired companies. “The culture issue is hard, but Cisco has been built on M&A. That’s what they do, so this is a core competency for them,” Wang told TechCrunch+.
Jevin Jensen, an analyst at IDC who watches companies like Splunk, says he thought the combo made sense last year when rumors of an acquisition first surfaced — and he still does.
The “announcement gives Cisco a market leader in observability and enterprise security, both delivered via SaaS for customers ready to move to the cloud, or on-premises for those industries with compliance regulations,” Jensen told TechCrunch+.
“These are capabilities that Cisco was lacking and should greatly improve their standing with enterprises,” he said.
But that all depends on Cisco not screwing up a good thing, and Allie Mellen, an analyst at Forrester, says that Cisco has had issues with its acquisitions in the past. “Cisco has long been a case study for acquisitions that don’t live up to their initial promise and suffer from underinvestment and a lack of focus. That said, in recent years they have maintained the Duo acquisition,” Mellen said.
“To keep Splunk’s massive, loyal user base, Cisco needs to let Splunk deliver what Splunk does best: a flexible, powerful [security information and event management service] and observability offering.”
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Wang said it comes down to something more fundamental in the M&A game. “They are buying $4 billion of ARR. They are buying customers,” he said.
What’s more, he thinks the company is trying to build this intelligence network, while continuing its journey from hardware to software. ”And now they’re doing in the two hottest spaces — AI and cybersecurity — and where else are they going to buy a company at this valuation in AI?”
But is it really worth that hefty price tag? That could be what has investors spooked.
It’s the money, stupid
Shares of Cisco fell in the wake of the deal’s announcement, closing at $55.50 the day before the transaction was announced and falling to as low as $52.71 per share at the end of trading on September 26. Since then, Cisco has regained some ground, though at $53.51 per share as of morning trading on Wednesday, Cisco remains underwater from its pre-announcement worth.
If the strategic elements of the deal seem solid as we noted above, the easy read of the situation is that Cisco is simply paying too much for Splunk; if the American networking giant is overpaying, it’s not hard to see why some of its own investors might be a little bit miffed.
Here’s what we see from our current perch, some time after the deal was first discharged onto the market:
- Cisco is buying something valuable. Splunk is big and, on an adjusted basis, pretty darn profitable. With nearly $4 billion worth of ARR as of its last earnings report, it also raised the expected results for ARR and total revenue growth for its current fiscal year. There’s a lot to like about Splunk as an operating entity.
- The revenue growth acceleration that Splunk can bring Cisco will be modest. When Cisco pitched the deal to its investors, it said that the buy is expected to be “cash flow positive and gross margin accretive in first fiscal year post close, and non-GAAP EPS accretive” in its second year, while also helping to “accelerate revenue growth and gross margin expansion.” Not bad, right?
- What was left unsaid is that while, yes, Splunk will help Cisco grow faster compared to its own prior-year comps, both companies are growing at around 16%. And Splunk is doing so from a smaller starting revenue base. So its accelerative impact won’t be massive on Cisco’s own growth rate, though it will be measurable. Returning to our question of why investors are seemingly blasé about the deal, it may be that Splunk’s growth rate simply means it can only move the needle so far at its future parent company, making the cost of its purchase a bit hard to stomach.
- So, is the company being valued like a growth stock or a cash cow? It better not be valued like a growth stock, right? Well, with $3.858 billion worth of ARR at the end of its most recent quarter, the company is worth about 7.3x its current annual recurring revenue. That makes it almost a little cheap compared to current revenue multiples that we can see in the market for its growth bracket. Essentially, it’s worth around the same multiple as Workday.
So far it’s a bit hard to say, “Hey, this company is dramatically overvalued compared to what we can see in the market.” That said, investors valued Splunk as low as $65 per share inside of the last year. That puts the price that Cisco is paying for Splunk, some $157 per share, into better context. Certainly, Splunk’s value had recovered ahead of the deal’s announcement — rising to as much as $119 per share before the news dropped — but Cisco is still paying a sharp premium to the value that public-market investors ascribed to the company after it rebuilt its value this year.
Is it a good deal?
If Splunk’s exit price by a very coarse multiples-comparison analysis doesn’t cause alarm inside the TechCrunch+ office(s), why was the company valued so cheaply in recent quarters? Put another way, who is more right: Cisco today, or investors a few quarters ago?
Going back through a few quarters of Splunk earnings, we can see a company that was working to control costs while still growing. In its Q1 F2024 results (three months ending April 30, 2023), the company bragged that it “generated 16% ARR growth while reducing non-GAAP operating expenses by 1% year-over-year,” which is the corporate way of saying ta-da!
Splunk is also moving toward a cloud-based subscription model, which always takes time. It is still doing material license revenues, which investors might not love, but given the sheer profit from that revenue, it hardly bothers us.
So what should we think about the Splunk deal? A fair read of the situation is that there’s opportunity cost to big deals; you can only do so many and so frequently. And if public-market investors are not convinced that the Cisco-Splunk tie-up will be as synergistic as the bankers on the deal, then they may simply view it as a large use of funds for a modest uptick in revenue growth. Throw in the fact that it doesn’t feel cheap, and you can understand why the market appears modestly skeptical of the transaction.
The bull case is that one plus one equals three when Cisco and Splunk tie the knot, but that will remain an open question until the combined entity has had quarters to self-digest. For now, the continued modest decline in value at Cisco is a warning sign that investors are not fully convinced.
Perhaps if Cisco had executed the deal a quarter earlier, at a discount to what it did, investors would be more content. That might have made the whole transaction sweeter to Cisco shareholders, if potentially anathema to Splunk backers. And thus, the high-wire tension of mega-deals. It’s hard to make everyone happy at once, even when $28 billion smackers is changing hands.
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