CrowdStrike Holdings Inc. (CRWD, Financial) is a cybersecurity company that provides endpoint security, threat intelligence and cyber attack response services. The company has outperformed the S&P 500 and the Nasdaq 100 since its initial public offering in 2019. While the stock is richly valued, I believe there is room for further upside.
The company is operating in a total adressable market that is growing by 22%. As spending in cybersecurity becomes top-of-mind for CEOs, driven by the proliferation of artificial intelligence, CrowdStrike is well positioned to drive innovation and market share in the coming years. The company has already seen its subscription revenue grow by 55% annually over the last two years and has seen deeper customer adoption across its product modules. While competitive threats remain a concern, I believe the company's product innovation, coupled with the management's focus on improving profitability, should help drive sizable upside for the stock from its current levels over a five-year investment horizon.
A primer on CrowdStrike's business model
CrowdStrike is considered a pioneer in the cybersecurity space. It is consistently ranked as a leader by leading technological research firms, such as in the Gartner Magic Quadrant and Forrester Wave reports. It is a cloud-native cybersecurity platform company that specializes in providing endpoint protection, managed threat detection and response services that focus on securing different types of endpoint devices within cloud networks (such as laptops, servers, mobile devices, virtual machines, etc.). It achieves this by deploying lightweight agents on endpoint devices that consume fewer endpoint resources, but still provide robust security by harnessing the power of the cloud. CrowdStrike's lightweight agent and cloud services are connected via the CrowdStrike Falcon cloud platform.
The company built its entire cybersecurity platform on the premise that the more data that it consumes from its client endpoints, the more intelligent its Falcon platform gets at fighting online adversaries. As a result, it also repurposes the data it consumes and repackages that as robust threat intelligence services to its clients via its Falcon Intelligence module.
I believe CrowdStrike's business model is a powerhouse of cybersecurity products and services, creating multiple avenues for compounded growth due to the benefits the platform has from its network effects and high switching costs. The company offers its cybersecurity modules via a mix of subscription-based tier pricing and add-on bundle pricing.
Building the bull case
One of the reasons investors may have strong preferences for CrowdStrike is because its management meticulously updates investors on their target market annually. I strongly favor such management practices as they help investors better track Crowstrike's market share. Based on the most recent Investor Day Presentation, the company's current total addressable market stands at $100 billion. For perspective, its TAM was growing at a compounded annual rate of 16% between 2019 and 2023, per an investor update briefing in 2022. However, its TAM has more than doubled since last year due to the proliferation of artificial intelligence.
CrowdStrike has also changed the scope of its target market from cloud-native to AI-native. As a result, the company now estimates its target market will grow at a CAGR of 22% to $225 billion between 2024 and 2028. In order to verify this, I also looked at external research to understand the sudden boom in its target market and found this report from Gartner published in October 2023 that alludes to CrowdStrike's TAM expansion. In the report, Gartner surveyed chief investment officers on the top technology areas they plan to invest in and found that 80% of them plan to increase spending in cybersecurity as they see AI as a threat to their internal cloud networks.
I believe these insights from CrowdStrike and external research companies portend strong signs in cybersecurity enterprise spending that bode well for it to continue to gain market share in the coming years. The company has already been growing its annual recurring revenue by 35% annually. Should management reach its revenue target for fiscal 2024 of $3.05 billion, the company should have a market share of around 3%. Moving forward, I believe the company should be able to grow its revenue faster than the growth rate of TAM in the mid-to-high 20-s range over the next five years as it acquires new customers and drives deeper product adoption amongst existing ones, aided by the secular tailwind of AI.
CrowdStrike's management is focused on improving profitability
In its fiscal third-quarter 2024 earnings call, CrowdStrike said it exceeded its top- and bottom-line expectations by 1.1% and 10.8%, respectively. In fact, the company has been beating its earnings expectations consistently over the last four quarters by an average rate of 16%.
Revenue saw a 35% jump to $786 million, while non-GAAP income from operations grew 96% year over year to $176.60 million. This led to an expansion in non-GAAP operating margin of close to seven points, from 15% in the third quarter of fiscal 2023 to 22.3%. This was mostly achieved by streamlining sales and marketing spend, which shrank from 34% of total revenue a year ago to 31% of total revenue.
In the meantime, the company also expanded its gross margin to 80% from 78% last year, which can be explained by higher module adoption rates, which improves the overall economies of scale.
For the remainder of 2024, CrowdStrike management is guiding for revenue in the range of $3.04 billion to $3.05 billion, which would mark a growth rate of 36% on a year-over-year basis. At the same time, Crowdtsrike is expected to grow its non-GAAP operating income by 78% to $634 million. This would represent an improvement in non-GAAP operating margin of five points to 20.8% in fiscal 2024. As per its long-term operating model, which the company laid out in its Investor Day Presentation, it should see further improvement in both gross and operating margins over the coming years, which will be driven by higher module adoption rates amongst customers as well as further streamlining its sales and marketing spend.
Building the bear case
Unfortunately, the market for cybersecurity products is fiercely competitive and rapidly evolving. CrowdStrike faces threats from competitors who are expeditiously innovating, and the company must keep up with or beat the pace of innovation. The company primarily faces competitive threats from two main segments of its target market.
- Traditional security vendors marketed legacy cybersecurity solutions such as malware prevention, firewalls, intrusion detection and phishing attacks. Most of these vendors have transitioned from legacy systems, such as on-premise, to cloud security to better position themselves against CrowdStrike. Traditional vendors include endpoint security providers such as Broadcom (AVGO, Financial) and VMware (VMW, Financial) and network security vendors such as Cisco (CSC), Fortinet (FTNT, Financial) and Palo Alto Networks (PANW, Financial).
- Emerging technology security vendors are new-age and provide cutting-edge technology that is much better positioned to compete with CrowdStrike. Vendors such as SentinelOne (S, Financial) and Cloudflare (NET, Financial) compete directly with CrowdStrike in cybersecurity markets such as endpoint detection and response, managed threat detection and response, identity access management and threat intelligence.
Moreover, the cybersecurity market also faces credibility risk due to the nature of its cybersecurity business, where adversaries are constantly changing tactics to gain unauthorized access to enterprise networks. If CrowdStrike fails to secure endpoints or, worse, gets hacked itself, it faces severe credibility risk.
Tying it all together, CrowdStrike could see an upside of 30% from its current levels
Taking CrowdStrike management's long-term operating model of non-GAAP operating margin of 28% to 32% and my assumptions for revenue growth in the mid-to-high 20s region as the company continues to drive new user acquisition and deeper adoption, it should produce a non-GAAP operating income of approximately $2.90 billion by 2029, which would translate to a present value of $1.90 billion if discounted at 8.50%.
While the stock is currently trading at a forward price-earnings ratio of 77 based on fiscal 2025 consensus earnings estimates, should the company successfully grow its non-GAAP operating income to a discounted present value of $1.80 billion by 2029, the price-earnings multiple will shrink to 35. In other words, the stock is currently priced at a price-earnings multiple of 35 should it reach its revenue and operating income targets as stated above.
I think there is room for multiple expansions over a five-year investment horizon, given the growth rate of both the top and bottom lines in an expanding TAM. While I would expect earnings growth to come more in line with revenue growth over the longer term (beyond 2029), as the company matures, I still believe CrowdStrike will be able to grow its earnings by 2.50 to 3 times the10-year S&P 500 average earnings growth of 8%. With the long-term average price-earnings multiple of the S&P 500 of 15 to 18, depending on the overall macroeconomic environment, this would mean CrowdStrike should be trading at a multiple of 42 to 45 in 2029, which would give the stock an upside of approximately 30% from its current levels to $380.
Conclusion
While CrowdStrike's valuation may initially look expensive to some investors, I think it is quite the contrary. Given the current price point of the stock, it can continue to climb higher over a five-year investment horizon as the company gains market share in a growing TAM, fuelled by the secular forces of AI, while improving overall profitability.
As an investor, I will be watching the overall competitive landscape and monitoring the trend in ARR and adoption rate for CrowdStrike to continue to assess my bullish thesis in the coming quarters. At the moment, I believe the company will be able to grow its revenue in the mid-to-high 20s range over the next five years while expanding its operating margins, which would translate to the stock having an upside of approximately 30% from current levels to a price target of $380.
