Bulls and bears are currently at crossroads with regards to CrowdStrike's (NASDAQ:CRWD) valuation. While CrowdStrike's growth is convincing institutional investors and hedge funds about the huge demand in the cloud security niche and how this merges with management's ability to acquire market share, traditional value investors are pounding the table in disbelief. In all fairness, only time will tell who is right or wrong. However, a careful analysis of CrowdStrike's competitive moat can provide a compass upon which to calibrate our investment philosophy. Essentially, the competitive moat helps to destructure the conundrum of the long term direction of the company.
Like Zscaler (ZS), CrowdStrike is up to early lead in terms of its brand positioning in the cloud security space. Investors and competitors are lapping up the growth story, and the double-digit growth is providing a strong launchpad for multiples to expand. The monetizable opportunity is big, and there's never been a better time to call yourself a cloud security company. This will make it easy for CrowdStrike to get into RFPs. The only concern is that CrowdStrike is focused more on endpoint security. Rather than protect the entire network like network security plays, CrowdStrike is restricted to companies with a heavy focus on a private/public cloud or hybrid cloud network topology. Though the proliferation of IoT devices expands the market, its inability to protect campus networks, mission-critical devices, or data centers puts a hard cap on its total addressable market, and RFP calls for large deals. I reckon CrowdStrike will continue to benefit from its early lead in the near term, and with enough cash on its balance sheet, it can extend this lead by acquiring smaller players. However, the level of competition in the EPP space (includes Microsoft (MSFT)) dilutes CRWD's future brand advantage in the cloud security space. CrowdStrike is collecting threat intel just as fast as existing network vendors. Therefore, I don't see it capitalizing on this to hit a massive home run. Though, it will be sufficient to keep the momentum near term.
CrowdStrike easily benefits from the network effect as its machine learning models can make better decisions as customers and attackers provide more data and files for its models to analyze. It also benefits from the global proliferation of internet-enabled devices and loads of data created daily. This improves its value proposition and breach detection rate. Over the years, the capabilities of its threat graph become unmatched, and it will be difficult for competitors to catch up as they have to win customers before their machine learning algorithm can become smart. Also, the value proposition of its threat intelligence graph becomes cheaper as its systems ingest more data. The only way this competitive moat can be lost is via a shift in network topology or design. Just like traditional firewall vendors have had to innovate due to the shift toward more cloud-based network solution deployment versus physical appliances, CrowdStrike will continue to reign in the cloud space in the near term in the absence of a massive shift to AR and VR work solution models. That scenario is currently far fetched as we are still in the early innings of the global digital and cloud transformation. This will confer strong near term revenue growth to companies that can take advantage of this trend.
This gains from the network effect. As customers protect more devices while providing more internal data from CrowdStrike’s system to analyze, the incentive to switch to another platform is watered down. Essentially, from a value perspective, CrowdStrike’s systems will be able to provide more intelligence and better insights per device protected compared to late entrants in the market. It won’t matter that late entrants have cheaper solutions; the quality of CrowdStrike’s detection and prevention solutions will make it tough for customers to switch to another platform. A machine learning model is as smart as the volume of data it can learn from.
From an industry level pricing perspective, CrowdStrike has little advantage. Microsoft and other AV players have commoditized the endpoint security space. Network firewall vendors can also discount to cross-sell their endpoint modules, which can be attached to their network security fabric.
Additionally, CrowdStrike is the only endpoint protection partner selected to build integration with Google’s Security Command Center (Alpha) which launched in March, providing real-time detection of threats originating on the endpoint.
A source of near term cost advantage remains its strategic partnership with Google (GOOGL) (GOOG). Google cloud recently surpassed $8 billion in revenue, and the company is planning to triple its sales force next year.
These new developments add to CrowdStrike’s robust Elevate Partner ecosystem, including but not limited to partnerships with Anomali, AWS, BluVector, Demisto, E8 Security (now part of VMware), Exabeam, IBM Security, Infoblox, Microfocus, Phantom, Sumo Logic, Swimlane, ThreatConnect, ThreatQuotient, Vectra Networks.
This gains from other factors and this is the compounding effect of early-stage investment in product development and branding. As CrowdStrike scales, it has a better understanding of how to optimize its processes to drive business efficiency. As a result, huge cost buckets like customer acquisition cost, R&D cost, and initial CAPEX investments come down.
The data suggests CrowdStrike will continue to enjoy the competitive moat that comes with being a cloud player making data-driven decisions for its clients via its threat intelligence and machine learning models. Its strategic partnerships with cloud platforms like Dell (DELL), AWS, and Google will continue to serve it near term. This provides some succors for investors who have been searching for a firm leg for its lofty valuation.
Any struggle to incrementally acquire more market share will lead to overheating and a sharp sell-off in stock price. CrowdStrike's efficiency metrics are already overstretched. Investors are only looking away due to its lofty growth. As it stands, the risk/reward towards a significant increase in valuation has been priced in.
Source: Seeking Alpha
The Quant factor grades also highlight the weakness in value and profitability for CrowdStrike's competitive cohort. Relying on growth alone can be a risky investing game. As a result, investors should tread with caution when reading into CrowdStrike's competitive moat.
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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.