gilaxia/E+ via Getty Images
Overview
Technology and paradigms shift, advance, and transform daily, but one constant holds – cybersecurity threats are getting more pervasive and sophisticated daily. International governments and public infrastructure are subject to crippling attacks, corporations are increasingly easy targets for ransomware schemes, and private citizens face the looming threat of identity theft and sensitive information leaks.
With the growing threat comes a burgeoning prevention and response industry, but not all firms are created equal. Already an undeniable standout amongst the crowd, CrowdStrike Holdings, Inc. (NASDAQ:CRWD) is a leader poised for dominance in the digital security, threat assessment, and prevention/response sphere.
Since its inception, CRWD has gained prominence and positive notoriety. Founded in 2011 in Sunnyvale, CA, before moving to Austin, TX (where it remains), CRWD enjoyed a flood of private funding from Google and prominent venture capital firms, seeing a valuation as high as $3B before going public in 2019 – where that valuation more than doubled, ranging around $7B after the dust settled.
The high valuation is well-deserved – from a news cycle perspective. Over less than a decade, CRWD:
- Helped the U.S. DOJ charge Chinese state-affiliated hackers with corporate espionage.
- Discovered that the DPRK was behind the 2014 Sony Pictures hack.
- Helped uncover the identities of a state-sponsored PLA hacking group called Unit 61486.
- Discovered the energy-targeting exploits of Russian FSB affiliates Energetic Bear.
And these are just a few examples. From the public, private, and government perspectives, CRWD is the name in cybersecurity. With its proprietary technology and methods and world-class talent, CRWD is undeniably a substantial firm with seemingly unlimited potential. But what about on a pure stock, financial basis? Is CRWD overvalued?
Recent Performance
It’s an uncertain time in today’s macroeconomic climate as corporations (and shareholders) look to trim the fat, implement cost savings, and focus on pure fundamentals. The days of cheap debt are gone as the Fed raises rates, and the software industry is taking the brunt of the abuse. A few notable sister companies stand out:
CrowdStrike? Up almost 2% YTD. So, what gives? Is CrowdStrike inherently better-off fundamentally and financially than even behemothic Microsoft? Let’s look at the big picture.
Sector
As we just saw, the broad software/information technology arena CRWD sits within is under siege from interest rate hikes and economic uncertainty. Private and public investors are less willing to place huge bets on future long-term growth prospects of unprofitable companies, and the flight to fixed-income and value/defensive stocks is in progress. Look at our three examples – PLTR, SNOW, and MSFT. Sure, the former two’s relative market cap collapses are understandable. Neither has turned a profit since IPO, and both were inarguably overvalued. But if there’s an equivalent of a value stock in CRWD’s competitive sector, it’s MSFT. Consistent earnings growth, stable innovation, and a consistent dividend yield are hallmarks of this “safe” sector stock, yet it’s underperforming the S&P500 by almost 6%.
Savvy investors should interpret MSFT’s relative underperformance as a canary in the coal mine. Yes, trading at a discount on its own but a clear market signaling flight away from any degree of uncertainty in the software/IT sector for the immediate future – deals for some stocks, to be sure, but uncertain outcomes for the glut of unprofitable, unsustainable growth stocks that plague the industry.
Profitability & Growth
In a nutshell, CRWD’s path to profitability is unclear to the average investor. During the days of cheap cash flow, CRWD elected to pour money into acquisitions that, in the future, may prove beneficial as profit drivers but currently serve to reduce operating income. This is compounded by the fact that many of the acquisitions were expensive bolt-on firms (companies that augment existing services), and CRWD paid a premium rather than developing the technology internally. Investors should also not expect a dividend as cash is poured back into operations, and shareholders can expect ongoing dilutive effects as convertible notes convert through 2029.
A more positive outlook is CRWD’s growth. There is no shortage of emerging, transforming, and changing cybersecurity threats. CRWD’s preeminent position means that they can charge a premium for the service with no likelihood of stemming the tide. Revenues consistently grow YoY, and their net operating income is offset by around $2B in cash on their balance sheet, allowing CRWD to secure growth prospects without immediate risk of ruin – and those prospects are strong, averaging almost 80% annualized growth over the past three years.
Valuation
We assess CRWD, currently at $194.6, as fairly valued. Much of the pricing is baked-in growth expectations, which are high with good reason. Still, some of CRWD’s specific ratios prevent a sunnier outlook on increased valuation (compared here against MSFT due to the drag-down effect of some comparable firms on industry index averages):
- P/B ratio of 40.97 compared to MSFT’s 12.35.
- P/S ratio of 27.25 compared to 10.49.
- ROE is -18.58% compared to 47.15%.
While these seem to contradict the fair valuation thesis, we believe that, although excessive compared to MSFT, these ratios are more than appropriate for a late-stage growth company like CRWD. The defining moment will be, as they progress through the 2020s, if and when they transition to a mature firm.
Risks
We’ve hit the primary macroeconomic and financial risk – what about operations? This is a more elusive and illusory risk but omnipresent. The future of the cyber threat landscape is unpredictable, and although CRWD has weathered all storms to date, there’s no guarantee that the track record will continue. This is compounded by a very narrow moat, with near-unlimited competition that could potentially have the solution to tomorrow’s problem today and leave CRWD in the dust. Especially as cloud migration takes full hold of the industry, customers have no incentive to remain loyal to a cybersecurity firm not meeting their needs, and CRWD has stiff competition.
Conclusion
CRWD is an undeniably strong operative firm with excellent prospects should it remain on its current glide path. Unfortunately, systematic and idiosyncratic risks are high, and CRWD’s current fair valuation means that current investors should hold. Still, most investors should wait for a more attractive entry in the $170-$180 range.
Be the first to comment