CrowdStrike Holdings: Growing niche

At present, CST offers 16 modules on its Falcon platform through a Software as a Service (SaaS) model that covers multiple large security markets, such as corporate workload security and threat intelligence services. CST’s SaaS revenue model is similar to most companies that deploy SaaS in the cloud computing industry — it is subscription based. CST offers cybersecurity solutions to customers of various sizes, ranging from those with hundreds and thousands of so-called “endpoints” for large corporations to as few as a handful for small- and medium-sized businesses. The endpoints refer to any device that is physically an end point on a network. These include laptops, desktops, servers, virtual machines, and Internet of Things (IoT) devices. A substantial majority of CST’s customers purchase subscriptions for a term of one to three years, where revenue from its subscriptions is recognised proportionally over the term of the subscription.

Our case for CST is that it is a leader in a niche industry set to grow at a rapid pace that should see it gaining market share. This makes CST a high growth company with strong financials and moat. Being in the cloud industry, the company’s business model, products and offerings should be focused on a few key metrics that we think CST is getting right. Companies in the cloud industry such as CST are dependent on the network effect for the growth in value of their businesses by offering scalable, subscription-based products and solutions. This means as CST’s customer base widens, its moat gets deeper and wider.

Additionally, CST, which utilises crowdsourced data, will benefit from the network effect and economies of scale, given how its AI algorithms would scale better with more data which enables the company to offer higher quality services and solutions that, in turn, makes it AI even more powerful, creating a virtuous cycle.

CST’s business strategy is centred around improving value through the network effect by building its customer base. Firstly, the company invests significantly in sales and marketing efforts to grow its customer base both domestically and internationally.

Secondly, CST’s flexibility and scalability of its Falcon platform allows it to rapidly expand its customer base as its open cloud architecture allows it to build and deploy new cloud modules at more efficiently. In 2017, CST transitioned its Falcon platform from a single module offering into highly-integrated offerings of multiple cloud modules. Given that many organisations have yet to adopt cloud-based security solutions, CST, which offers solutions for organisations of all sizes worldwide and across a plethora of industries, is likely to build its customer base at a faster rate compared to peers.

CST also has an edge when it comes to new customer acquisitions, as its incident response and proactive services have resulted in many customers subsequently purchasing subscriptions on its Falcon platform.

The global cloud computing industry, at least over the next three years, is deemed to be a highgrowth industry according to market intelligence. The Covid-19 pandemic has been a catalyst for the cloud industry and market survey indicates that almost 70% of organisations using cloud services today plan to increase their cloud spending in the wake of the disruption.

The rationale is that the pandemic has caused organisations to focus on preserving cash, optimising IT costs, and supporting and securing a remote workforce — all of which the proponents of cloud computing say will address. The 2021 growth forecast is at 18.4% for worldwide end-user spending on public cloud services. Further, the proportion of IT spending that is shifting to cloud in the aftermath of the pandemic is expected to accelerate, with cloud projected to make up 14.2% of the total global enterprise IT spending market in 2024, up from 9.1% in 2020. The total addressable market for CST and cloud security is huge and expanding, with the cloud security opportunity expected to double to US$12.4 billion ($16.5 billion) in 2024 from US$6.1 billion in 2020, according to market intelligence.

Though the cloud industry is expected to do well in the near term, only companies that have a competitive advantage stand to gain most from this growth forecast. For instance, leading companies in cloud security, CST has an edge over its peers because of its large business exposure to the cloud infrastructure software compared to peers who have other non-cloud security businesses. As CST’s competitors are mainly large security appliance vendors that have non-cloud offerings, they will have to compromise their product sales because of workload migration to the cloud.

Being native to the cloud security market, CST also has the competitive advantage over peers as it has better offerings in terms of functionality and efficacy due to better technology. CST is also expected to grow at a much faster pace compared to the overall cloud security market over the next few years. Last September, the company announced the US$96 million acquisition of Preempty Security. The target, which operates in the cloud identity protection sub-market, should further deepen its moat, quality and range of its offerings.

In 3QFY2021 ended Oct 31, 2020, CST performed well, posting 81% y-o-y growth in its annual recurring revenue, while gross margins improved to 78% from 76%. Though the company is making losses — mainly due to heavy marketing and sales expenses — this is expected to turn around by the end of FY2022. The company turned operating and free cash flow positive five quarters ago, showing good signs of better cash generation through strategic investments and improvement in business value.

Business-wise, CST’s prospects have taken a very positive turn due to the pandemic, where management had double-digit positive revisions to their top-line growth expectations for FY2021 amid faster customer additions and increasing adoption of their add-on security offerings. In terms of financial health, the company is in a solid position, where its cash and cash equivalents alone are enough to cover total liabilities. Chart 1 shows CST’s historical customer retention rate, which is indicative of the rapidly growing value of the business.

Analysts have given a target price of US$217.38, which is slightly lower than its current trading price of US$223.53. Our in-house valuation of the company indicates that CST has the potential to offer over 25% returns over the next 12 months. Investors should not be clouded by the fact the company’s share price has almost quadrupled over the past year, but realise that the company still has much room for value growth in a burgeoning industry.