Bear markets should be celebrated as opportunities to purchase quality growth assets at a significant discount. It’s also a time when companies with subpar business models come under scrutiny. Selling promises of future growth becomes very difficult which is why special purpose acquisition companies (SPACs) have come crumbling down with more than 40 of the 100 we’ve covered having lost 75% or more. While there may be value in some of these names, nearly 70% have a market cap less than $1 billion which means they’re off our radar.
Over the past several months, we’ve been evaluating stocks we “like” to see what quality companies we might add that are trading at bargain prices. One name that’s surfaced is CrowdStrike (CRWD), a $32 billion firm we last covered in an April 2021 piece titled Which of The 3 Biggest Cybersecurity Stocks is the Best? Today, we want to revisit the stock and cybersecurity thesis.
Cybersecurity spending isn’t going anywhere, and we want in on that action.
Nanalyze, April 2021
Investing in Cybersecurity
On a spectrum of maturity, themes like space are early to the party while cybersecurity has been around for decades. Mature themes always have lots of publicly traded stocks to choose from which is why we initially invested in cybersecurity stocks by simply purchasing an ETF. With eight cybersecurity ETFs to choose from, we found the Global X Cybersecurity ETF to be the most compelling. Later on, we decided not to hold any ETFs in our tech stock portfolio, and promptly replaced the position with an investment in Okta (OKTA). While we really like CrowdStrike, it’s been significantly overvalued since their 2019 IPO:
The old land-and-expand appears to be working well, and investors are willing to give CrowdStrike a rich valuation for the promise of an equally bright future. We could just look past that big valuation number and get a position opened, then add to it when it inevitably corrects.
Well, that inevitable correction is finally here. When we made the above comments, CrowdStrike’s simple valuation ratio was above 40. Today, it’s just below 15.
- $31.7 billion market cap / annualized revenues of $2.141 billion = 14.8
These days we won’t buy a stock with a simple valuation ratio greater than 20, and we won’t add to a position unless it falls 50% below our cost basis or more. Given the carnage we’ve seen this year, this conservative approach seems merited. Today, we want to decide if CrowdStrike’s current valuation represents a good entry point.
Traditional price-to-earnings ratios don’t work well for high-growth firms that don’t have positive earnings. It’s why we came up with a simple valuation ratio that looks at a company’s size relative to their annualized revenues. Here’s that number calculated for CrowdStrike using the latest quarterly revenues – Q2-2022 – and the midpoint of guidance for Q3-2022 (results to be released on November 29th).
- Q2-2022 – $31.7 MC / (4 * .535) = 14.8
- Q3-2022 – $31.7 MC / (4 * .5725) = 13.8
In other words, the revenue increase next month will drop the simple valuation ratio by one point – from 15 to 14. Here’s how these numbers compare to fifteen of the world’s largest SaaS firms.
|Company Name||Market Cap||Last Quarter Revenue||Simple Valuation Ratio|
|SNOWFLAKE (SNOW)||$ 47||0.497||24|
|ZSCALER (ZS)||$ 20||0.318||16|
|CROWDSTRIKE (CRWD)||$ 33||0.535||15|
|DATADOG (DDOG)||$ 24||0.436||14|
|VEEVA SYSTEMS (VEEV)||$ 29||0.534||14|
|INTUIT (INTU)||$ 112||2.41||12|
|SERVICENOW (NOW)||$ 83||1.83||11|
|ATLASSIAN (TEAM)||$ 32||0.807||10|
|ADOBE INC. (ADBE)||$ 156||4.43||9|
|AUTODESK, INC. (ADSK)||$ 43||1.24||9|
|SHOPIFY INC. (SHOP)||$ 46||1.37||8|
|WORKDAY (WDAY)||$ 38||1.54||6|
|ZOOM (ZM)||$ 23||1.1||5|
|SALESFORCE, INC. (CRM)||$ 152||7.72||5|
|BLOCK, INC. (SQ)||$ 38||4.52||2|
CrowdStrike is on the rich side, but not far away from the cheapest it’s been since becoming publicly traded. When the market crashed because of the Rona, CRWD traded at $39.55 a share, a ratio of 12.5. The recent 52-week low of $120.5 translates to just about the same – a simple valuation ratio of 12.6. We can conclude anything below 13 is cheaply valued relative to historical valuations, and perhaps set a target of 15 to provide some wiggle room. We’ll then wait until after earnings next week and see what the valuation looks like then. CrowdStrike has beat earnings guidance for the past four quarters so investors will be expecting nothing less. Should they deliver on track or below expectations, hopefully the market totally overreacts, and shares plummet.
Revisiting The Thesis
It’s important to remember why we find CrowdStrike a compelling way to play cybersecurity. It’s one of the three largest cybersecurity companies out there behind Fortinet (FTNT) and Palo Alto Networks (PANW), two firms that dabble in a completely different cybersecurity segment called network security where they compete with names like Checkpoint Software (CHKP) and Cisco (CSCO). CrowdStrike’s foundation is endpoint protection where they’ve taken a large lead alongside a $1.8 trillion giant that’s the third largest company in the world by market cap – Microsoft (MSFT).
Any device that connects to a corporate network – servers, laptops, smartphones, IoT devices, etc. – is considered an endpoint. CrowdStrike provides protection for every device that exists on a corporate network, and then goes beyond that with added modules of functionality.
One of the largest and most well-known software-as-a–service (SaaS) companies out there is Salesforce, a firm that CrowdStrike compares itself to. Where the comparison holds true is in the modular approach that both companies take when selling services. When describing their total addressable market (TAM), CrowdStrike breaks it down into modules that each represent a vertical portion of TAM that expands their total opportunity ($58 billion presently).
With a run rate of $2.14 billion, they’ve captured less than 4% of the pie thus far. The size of the opportunity will expand organically and from additional capabilities that CrowdStrike develops or acquires. In the above diagram you can see how they added log management services with last year’s acquisition of Humio.
The land-and-expand approach is working well for CrowdStrike with nearly 60% of their customers purchasing five or more modules and 20% purchasing seven or more. It’s also reflected in their net retention rate which has leveled out to a baseline of around 120%, while gross retention has risen above 98%.
Let’s review the reasons why CrowdStrike seems like a compelling addition to our tech stock portfolio:
- Cybersecurity is critically important to firms of all size in every industry. It’s not a nice to have.
- CTOs don’t want to cobble together cybersecurity solutions in hopes that they’ll play well together. Holistic cybersecurity solutions help firms sleep well at night.
- A Forrester study (commissioned by CrowdStrike) shows the ROI of purchasing a holistic solution with a payback measured in months
- CrowdStrike is one of the largest cybersecurity firms out there
- Close to 80% gross margins, $2.3 billion in cash, and a burn rate of about $50 million a quarter mean survivability won’t be an issue.
- CrowdStrike utilizes an attractive SaaS business model and sits in our size sweet spot with a $32 billion market cap
- Quarterly earnings decks present key metrics that are easy to follow
- International revenues have been consistently growing over time and represent 28% of 2021 revenues.
- Private equity firms have begun scooping up cybersecurity firms (KnowB4, Ping Identity, Forgerock, Darktrace though it fell through) which helps provide price support.
Both CrowdStrike and Snowflake have always been the highest valued stocks in our tech stock catalog because of their consistently high growth. As the bear market’s tide sinks all ships, a simple valuation ratio target helps us decide when to buy quality names. For example, we’re buying Snowflake at a simple valuation ratio of 20 or less. For CrowdStrike, we believe that number is probably 15 or less. While these targets are completely arbitrary, they provide an objective method to ensure we’re accumulating at a consistent valuation as time goes on.
CrowdStrike reports earnings on November 29th with guidance of $569.1 – $575.9 million and a track record of consistently surpassing their forecasts. At the midpoint of guidance, the simple valuation ratio will change by about one point. Our plan is to wait for the earnings dust to settle and possibly go long the stock at a simple valuation ratio of 15 or less.
To quote the Oracle of Omaha, it’s better to buy a great company at a fair price than a fair company at a great price. CrowdStrike’s valuation may fall even further which is why dollar cost averaging is always the best way to invest in any stock. With the firm’s valuation having adjusted to more reasonable levels, we may consider adding them to our own tech stock portfolio. Should we decide to open a position in CrowdStrike, Nanalyze Premium subscribers will be the first to know.
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