Olivier Le Moal
Cybersecurity has been a resilient business in 2022, regardless of the sector’s stock price performance in the same period. But the effects of macroeconomic headwinds are inching their way into even this resilient and top-priority sector of technology. The problem is not all players are feeling the effects in the same way. After comparing Zscaler’s (NASDAQ:ZS) earnings with CrowdStrike’s (NASDAQ:CRWD) earnings, there are winners and losers among the lead pack. These differences expose the stronger company and will have long-term positive implications for its shares once the broad market selling relents.
Head-To-Head Earnings
CrowdStrike reported earnings two days before Zscaler’s, making for a convenient setup to compare both competitors. In CrowdStrike’s report, it was clear the company started seeing the ripple effects of enterprise spending hitting its business. Its ARR (annual recurring revenue) for the quarter came in below the company’s and Street’s expectations, growing only 16.5% after averaging low-to-mid 40 percent growth the last year-and-a-half.
This became point number one to compare.
But the next point was the more telling piece of the puzzle: what does the sales cycle look like, and have the economic factors impacted how sales are closing?
CrowdStrike’s answer was eye-opening.
But only the latter part of the answer.
The first part of the answer seemed very typical for IT spending habits in tough times. As budgets tighten at enterprises, the scrutiny of purchases grows. This is not atypical, and both CrowdStrike and Zscaler had similar things to say. But they were not saying the same things in the same way. The story beyond longer sales cycles couldn’t be more different.
CrowdStrike’s Sales Story
Starting with CrowdStrike, the company talked about its deals taking longer to close due to the extra layer of approvals as macroeconomic conditions worsened.
…organizations were starting to respond to macroeconomic conditions by adding extra layers of required approvals and extending the time it took to close some deals.
As Q3 progressed and fears of a recession grew, this dynamic became more pronounced. In our smaller, more transactional non-enterprise accounts, we saw customers increasingly delay purchasing decisions with average days to close lengthening by approximately 11% and net new ARR contribution decreasing $15 million from Q2.
– George Kurtz, CEO, CrowdStrike FQ3 ’23 Earnings Call
As I said, this isn’t unusual in the IT world, and the headwinds CrowdStrike saw weren’t surprising. But the problem is this isn’t the end of the explanation of what’s happening in the sales cycle. It gets more concerning.
The company went into detail on how it has had to move into phased implementation approaches. This is where customers sign tiered contracts stipulating increasing commitment to the invoice and software implementation level over quarters or maybe even years. In other words, instead of signing a $10M contract for three products up front, as an example, the contract is broken into $3.3M pieces, installing one product at a time until the following year when the next phase is scheduled and the second product and next $3.3M is delivered, and so on.
…some also had to manage timing issues related to OpEx budgets and cash flow amidst the rapidly evolving macro.
To achieve this, some customers signed contracts that have multi-phase subscription start dates, which pushes their expense and CrowdStrike’s ARR recognition into future quarters. While every quarter, we have some deals with multiphase subscription start dates, in comparison to last quarter, in Q3, we saw approximately $10 million more ARR deferred into future quarters. We expect these macro headwinds to persist through Q4.
– George Kurtz, FQ3 ’23 Earnings Call
The company is capitulating to get contracts signed, sacrificing upfront revenue and ARR for at least the commitment the customer will eventually start paying for all of what’s expected. But management insists this is just a lot of delay and not much loss.
While sales cycles lengthen, we believe the vast majority of these deals are not lost, just delayed.
– George Kurtz, FQ3 ’23 Earnings Call
But this is where I found troubling detail about what’s happening with the rest of its contracts.
We also expect more multiyear deals converting to one year renewals than in previous quarters.
– Burt Podbere, CFO, CrowdStrike FQ3 ’23 Earnings Call
This is an interesting data point.
Multi-year deals converting to one-year deals don’t provide me with warm fuzzies. Though, this isn’t unusual even outside of economic pressures. For example, contracts I’ve worked on will only renew for a year if the underlying contractor contract is up for bid and the outcome is still pending (in which the project may not exist past the year). Even then, I have a major vendor we do yearly renews regardless of the project contract length.
But the issue here is the transition from multi-year to one year – this is eyebrow-raising. The lower growth of ARR in Q3 and the expected negative year-over-year growth of ARR for the current quarter confirm this.
Zscaler’s Story Doesn’t Corroborate
The report from Zscaler (all of two days later) had some pretty similar comments. I’ll start with the commonalities and then move into what is not only different but starkly opposed.
…we saw additional deal scrutiny and longer reviews on most deals…
– Jay Chaudhry, CEO, Zscaler’s FQ1 ’23 Earnings Call
Longer reviews and a longer sales cycle match CrowdStrike’s view. But the views started to diverge from there.
…pursuing a strategic initiative to modernize the business, our top 10 global banks made a four-year $10 million per year commitment for Zscaler for users driven by cloud adoption, including Microsoft 365 and Zoom.
…
…while there are broader macro challenges and economic uncertainties, we are seeing an increase in large multi-year commitments for multiple product pillars.
– Jay Chaudhry, Zscaler’s FQ1 ’23 Earnings Call
This is telling and a stark contrast to its peer’s results two days before.
CrowdStrike is saying, “expect more multi-year deals [to convert] to one year renewals,” while Zscaler says, “we are seeing an increase in large multi-year commitments.”
The next natural question is, why is this?
These two companies have a difference in engagement. Zscaler is working directly with its customers, closer with its CIOs, and directly with customers’ C-suites. But it isn’t just talking to them; it’s showing the ROI (return on investment) they can expect more clearly.
One is customers look for better business justification. That’s what I mentioned on CFO-ready business cases, business value assessment, which we do to help quantify them. If you remove these eight-point security and networking products, this is the ROI you can get. And in fact, we’re showing more than 200% ROI in many most majority of our cases. That’s very strong. It’s — we’ve done it. We’re doing a better job in that area.
The second thing to get deals done in a tougher environment is having strong C-level engagements, because you’re going to make a case there to show what needs to be done. And also, if you’re part of the CIO’s budget rather than just security budget, you actually have a better chance of doing it.
– Jay Chaudhry, FQ1 ’23 Earnings Call Q&A
Working in enterprise software and directly with vendors, I can tell you getting concrete ROI numbers is not easy. The salespeople will throw out templated numbers and explain what my contract can expect. But, unfortunately, that’s not good enough; no one fits the mold exactly.
Now, yes, some customers will say, “we’re not like anyone else,” and that’s because they’re mismanaged and have created a terrible path where they have diverged from all best practices. So they wind up doing things the hard way, and no one can tell them their ROI because they don’t know it for their own clients.
But when a vendor can dig deep and see the bigger picture at a customer, gaining access to the entire CIO budget, it becomes much easier to show where savings can be made and what the return is. As a result, Zscaler appears aligned with its customers as partners and not just as another vendor.
Comparing Style Notes
Zscaler’s approach is a competitive tactic and just plain good ol’ vendor partnership.
If CrowdStrike can’t engage to this level, it will lose to the company making the better case for Zero Trust Architecture and relevant security. This is clearly stated, with one seeing renewals go from long to short periods while the other is seeing an increase for more multi-year deals.
What also concerns me is CrowdStrike did admit some of its deals are being lost. Remember, CRWD’s management said, “we believe the vast majority of these deals are not lost, just delayed.” This implies some are being lost.
Perhaps Zscaler is taking share?
But this isn’t just a matter of poor managerial communication on an earnings call or a misunderstanding on my part. This has led to the difference between these two companies missing or exceeding guidance.
| CrowdStrike | Zscaler | |
| Consensus Revenue | $632.8M | $358.55M |
| Guided Revenue | $623.5M | $365M |
| Difference $ | -$9.3M | $6.45M |
| Difference % | -1.5% | 1.8% |
There are other factors involved in these guides, of course. Still, CrowdStrike is seeing a prolonged period of weakening sales (more than one quarter) as it struggles to renew long-term contracts and even loses some deals. Zscaler, on the other hand, is acknowledging the tough conditions yet closing bigger, lengthier deals.
Competitive Pressures Show Themselves In Tough Times
Now, both stocks may do well over the next two-to-three years regardless. I could be nitpicking, but I don’t believe I am. Small but meaningful differences like this can set the trajectory of a company’s ability to execute above or below the market. You also can’t ignore the risk profile it brings with it.
Because of this startling difference in sales wins and the type of deals being closed, I have come to favor Zscaler over CrowdStrike. Initially, I was planning to initiate a position in CRWD if earnings showed decent performance or at least comparable performance to ZS, but this has shifted my view away from CRWD due to its ability to execute.
Tough times determine whether a company is built to weather them. When cracks in the armor show, the ability to survive the storm decreases. Determining whether cracks in the armor are showing is much easier when you can directly compare. In this case, these two competitors provided a great example of one struggling and one overcoming with earnings centered on the same topic.
I’m concerned Zscaler is taking share from CrowdStrike, and the latter is losing the competitive battle. Right now, I’ll keep my investment in ZS and hold off on CRWD. Both stocks will struggle right along with the market in the short-term, but when the time comes to add to my cybersecurity positions, ZS will get first-in-line treatment.
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