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Source: CRWD 1Q21 Investors Presentation

Investment Thesis

In a May article, I explored Crowdstrike Holdings (CRWD) in-depth highlighting its position as one of the leading endpoint, cloud-deployed cybersecurity companies of the 21st century. The company is truly at the heart of a secular growth trend in cloud-deployed endpoint security in a world of decentralized work environments.

With that being said, everyone and their mother knows this; hence, the stock has been bid up to a lofty valuation. Throughout this article, I will highlight Crowdstrike’s big wins, relate recent developments, and ultimately share with you my rationale for increasing the rate at which I project free cash flow per share to grow during the 2020s, which thereby increases the present value of the company and its long term expected returns.

My updated valuation, using the L.A. Stevens Valuation Model, illustrates that Crowdstrike continues to become more appealing as management continues to demonstrate their executional prowess.

Delving Into The Recent Quarter

Recently, I attended Crowdstrike’s Q1 2021 earnings call, and the company certainly communicated heartening results. Crowdstrike went into the quarter expecting to generate $728.4M in revenue for 2021, but actually did $766.9M, including $686 million in annual recurring revenue.

In the earnings call, CEO George Kurtz remarked,

“We believe work from home and digital transformation are sustainable trends for our business. It is mission-critical to protect workloads irrespective of where they are located on or off the corporate network. We believe these trends have helped increase our leadership in the security cloud category that we pioneered.”

Today, I am going to illustrate:

  • How Crowdstrike assisted companies in their transition to digital, which led to heartening results
  • That Crowdstrike is anticipating the strong quarter to contribute to future revenues
  • Using the L.A. Stevens Valuation Model, Crowdstrike is a strong holding at the right price.

Source: CRWD 1Q21 Investors Presentation

Highlights From The Call: The Transition to Digital

The virus expedited many companies’ transition to digital, and this played right into the hands of Crowdstrike because of its cloud-deployed endpoint security strategy. Data is currently at greater risk than ever as more people work from home, but Crowdstrike provides the ideal endpoint security solution that deploys easily, securely, and efficiently.

One of Crowdstrike’s wins from the quarter was landing a deal with a leading European logistics company, who implemented Falcon Complete in only seven days. The company originally intended to develop its own security operation center but realized that using Crowdstrike would be more effective because it allowed them to consolidate a security program into one constantly evolving agent. This allowed the company to quickly transition to digital and saved it time and money, as was related on the conference call.

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This is a trend I expect to continue as companies would rather turn to a trusted, easy-to-integrate protection service than to developing their own protection service, which is costly and time-consuming. Further, with the creation of “cloud stacks”, i.e., cloud services a company purchases, these cloud providers are constantly under pressure from the free market. That is, gone are the days of in-house, clunky IT bureaucracy. Corporations can now leverage the free market at all times by purchasing the services of constantly evolving companies, such as Crowdstrike, or Workday (WDAY) as another example.

Additionally, Crowdstrike expanded its relationship with a major U.S. airline and initiated a new contract with one of the largest semiconductor manufacturers in the world, which they decided to leave unnamed on the call. Crowdstrike also played a role in ensuring that healthcare systems were protected as hospitals were limited in staff and receiving a rapid increase in patients.

The previous examples of wins from the quarter highlight that Crowdstrike serves a large swath of businesses in different segments.

Source: CRWD 1Q21 Investors Presentation

Crowdstrike’s superb quarter was supported by a number of statistics that reflect how the company retains customers while upselling and cross-selling its services. Crowdstrike added 830 new subscription-based customers in the quarter, bringing its total subscription-based customers to 6261, a 105% year-over-year growth (as illustrated above).

The Most Important Metrics: Retention Rates

Gross retention continues to be a strong indicator of Crowdstrike’s sticky customer base. Gross retention measures how many customers a company retains (i.e., 90% means they retain 9/10 customers). Crowdstrike sported a 98% gross retention rate in the quarter, which is rather astounding… perhaps even unheard of. Crowdstrike is retaining almost all of its customers, which is extremely important because it depends on annual subscriptions to drive revenue.

Source: CRWD 1Q21 Investors Presentation

As can be seen above, dollar-based net revenue retention (or net retention rate for short) was 124%, an indicator that Crowdstrike’s customers are spending 24% more than they did the previous year. This means that Crowdstrike’s current customers continue to subscribe and are adding more services to subscriptions. This is essential to the understanding of an “as a service” company, as it highlights that the company is constantly evolving its offering, which further highlights the quality of management and its vision.

Because Crowdstrike upsells and cross-sells its services, the company anticipates its new customers to contribute to strong revenues in the coming years.

Growth In Revenue Set To Deliver

Source: CRWD 1Q21 Investors Presentation

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Crowdstrike had a great quarter growing revenues at high growth rates, as can be seen above.

Source: CRWD 1Q21 Investors Presentation

As can be seen above, Crowdstrike is steadily increasing ARR (annual recurring revenue).

Source: CRWD 1Q21 Investors Presentation

Now that we understand Crowdstrike’s exceptional quarter, let’s find what Crowdstrike is really worth.

L.A. Stevens Valuation Model

Here, we will employ our proprietary valuation model. Here’s what it entails:

  1. Traditional discounted cash flow Model using free cash flow to equity discounted by our (as shareholders) cost of capital
  2. Discounted cash flow model including the effects of fluctuations in shares outstanding
  3. Normalizing valuation for future growth prospects at the end of the ten years. (3a.) Then, using the current stock price and the estimated stock price at the end of 10 years, we get a CAGR. If this beats our hurdle rate by a considerable margin, we invest. If not, we wait for a better buying opportunity.

Notably, I revised the rate at which Crowdstrike is expected to grow on average to 22.5%. I feel that this is a conservative estimation by which I can implement a strong margin of safety.

Now, let’s check out the results!

Assumptions:

Assumption

Value

Free cash flow per share

$1.26

Free cash flow per share growth rate

22.5%

Terminal growth rate

2%

Years of elevated growth

10

Total years to stimulate

100

Discount Rate (Our “Next Best Alternative”)

9.8%

Source: L.A. Stevens Valuation Model

As can be seen above, a DCF would illustrate that Crowdstrike is overvalued at present. But DCFs do not paint the entire picture.

The fatal flaw of a DCF is its implementation of a terminal growth rate. It would take an unrealistic predictive ability to truly discount every year of cash flows a company will generate over its lifetime, so we must use the 3rd step of the L.A. Stevens Valuation Model to determine projected returns.

I like to think that the DCF component gives us a general idea of under or overvaluation.

The third step truly tells us where/when to buy. So let’s do it!

Expected Return

Of note, I chose to grow 1.26 at 22.5% for ten straight years, at the end of which I assigned a price to free cash flow multiple of 35x. I then used that 2030 price target to create a CAGR, which you can see below.

Source: L.A. Stevens Valuation Model

Margin of Safety

In my previous Crowdstrike article I used a 20% growth rate for free cash flow, but increased this to 22.5% for this calculation to reflect the latest guidance for this fiscal year. Since annual revenues are growing at such high levels year-over-year, I think that an average of 22.5% is still conservative for Crowdstrike’s growth.

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So with 31% for the next two years, they will have to do an average of 20.37% for the remaining 8, which is manageable.

Palo Alto Networks (PANW), which is significantly more mature and offers a far inferior product, just did 20% in a recent quarter. So we can safely assume Crowdstrike will be able to do 22.5% over the next 10 years.

With that being said, we still want to implement even more of a margin of safety, so while it currently offers about 11% annualized returns, I think the $80s is the best point at which to buy the stock, though you won’t get hurt picking it up in the $90s.

Concluding Thoughts

Crowdstrike had an incredible quarter during a volatile and uncertain time. There is no doubt that Crowdstrike benefits from the transition to digital, decentralized work environments, the trend of which has been expedited due to the virus. Crowdstrike saw this translate to increased revenue and expects this to further increase its ARR, while developing a strong pipeline of subscribers.

While the price fluctuates and has risen 20% this past week to new highs following the earnings report, I rate Crowdstrike a buy as it hovers around $95. I think there could be a pullback as the stock boomed after its strong earnings, which could be an opportune time to go all-in on a position.

For those who bought it at our last recommendation at $66, I hope you found this update on Crowdstrike useful and continue to make smart investments based on our conservative recommendations.

As always, thanks for reading; remember to follow for more, and happy investing!

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Disclosure: I am/we are long CRWD, PANW. 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.