CrowdStrike: Shares Look Overpriced Despite Attractive Fundamentals (NASDAQ:CRWD)

CrowdStrike (NASDAQ:CRWD) is gearing up for accelerating commercial momentum in 2024, after a strong performance in 2023. According to various CIO surveys, IT budgets are set to expand in 2024, and within IT, the demand for cybersecurity is anticipated to outpace the broader software spent. On that note, I agree with analysts that a 25% YoY topline growth for CrowdStrike may be reasonable over the next 4 quarters. This growth is highly valuable for investors, as CrowdStrike generates approximately 36 cents in free cash flow for every dollar of incremental sales.

Despite these positive fundamentals, investors should not forget that every investment opportunity is also a function of valuation. And on valuation, CrowdStrike stock looks overpriced, with CRWD shares trading at a 22x EV/ Sales and a 103x EV/EBIT (projected 2024 Sales and EBIT). Considering such aggressive valuation multiples, I doubt that CrowdStrike investors will achieve alpha-rich returns in 2024.

For context, CrowdStrike stock has strongly outperformed the broad equities market in 2023, also when compared to the “Tech” benchmark. For the trailing twelve months, CRWD shares are up about 189%, compared to a gain of approximately 20% for the S&P 500 (SP500) and a gain of close to 47% for the Nasdaq tech-heavy Nasdaq 100 (QQQ).

Cybersecurity Could Thrive in 2024’s Bull Market…

As we approach 2024, the overall outlook for IT budgets is showing signs of improvement. This trend is echoed in the insights gathered from various Q3 conference talks, which highlighted a reduction in sales cycles for new clients and faster billing processes for existing ones. Such a shift is particularly beneficial for cybersecurity investments, in my opinion, as the urgency for robust cyber defense mechanisms is escalating due to increasing geopolitical tensions and the complex security challenges emerging from GenAI developments, including deep-fakes, data poisoning, and adversarial attacks. In that context, Qualys reported a notable 26,447 disclosed vulnerabilities in 2023, surpassing 2022’s count by over 1,500 and marking a seventh consecutive year of rising vulnerabilities. Similarly, ransomware attacks were up 72% YoY in 2023 vs 2022, with hackers increasingly employing new GenAI tools to develop malware at an accelerating pace.

Aligned with the increasing threat environment, the Piper Sandler 2024 CIO Survey (published on December 11th) presents a bullish perspective for cybersecurity spending, placing security spending at the top of IT budget decision-makers priorities. In that context, survey participants place special emphasis on areas like Cloud Security, Endpoint Security, Threat Intelligence, and Network Detection & Response – areas that are strongly aligned with CrowdStrike’s expertise. Similarly, surveys conducted by UBS, Jefferies and Morgan Stanley underscore the anticipated increase in cybersecurity budgets, pointing to the adoption of GenAI and its related security implications as key areas of concern.

…With Structural Growth Supporting Long Term Expansion

From a more structural growth perspective, investors should consider that the cybersecurity market continues to expand significantly. In fact, Gartner projected that the Total Addressable Market for the cybersecurity industry topped $188 billion in 2023, growing about 13% YoY. Moreover, greater than double-digit YoY growth rates are expected to persist through the next 5 years, as cybersecurity is projected to claim an increasingly larger share of overall IT spending.

On that note, I point out that CrowdStrike is strengthening its position of market leadership as a SaaS security platform. The company has a strong track record of gaining market share within the core endpoint market, along with the increasing adoption of its emerging modules (such as identity protection and cloud workload protection). In addition, CRWD’s ongoing strategy to expand beyond endpoint security, particularly with LogScale’s integration that merges cybersecurity and infrastructure, is enhancing CRWD’s integration and engagement with its customers.

On a different note, CrowdStrike looks well positioned to leverage AI, as I believe that larger platforms like CrowdStrike and Palo Alto stand to benefit the most from AI advancements. Investors should consider that having access to extensive data enables these companies to train AI models more efficiently and allows for a comprehensive view across various segments of a customer’s cybersecurity landscape. This capability facilitates the correlation of data from different sources, such as linking endpoint data with identity data.

Expect ~30% YoY Topline Growth In 2024 On High FCF Margins

As discussed in previous sections of the article, CrowdStrike is well positioned to capture a large share of the increasing demand for cybersecurity in 2024 and beyond. In more detail, analyst consensus currently projects ~30% topline growth in 2024, followed by 25% growth in 2025. I think the estimated growth, although high, should be a reasonable benchmark for CrowdStrike’s revenue outlook.

Reflecting on CrowdStrike’s growth, investors should take into account the significant value that additional revenue brings to shareholders. For every dollar of incremental sales, CrowdStrike currently generates approximately 0.36 cents in free cash flow. And as the company gains scale, positive operating jaws may push the free cash flow margin closer to 40%.

If we assume that CrowdStrike grows its revenue to $5 billion by end of 2025, as estimated by consensus, and apply a 40% free cash flow margin, then we may reasonably project CrowdStrike’s 2025 FCF at about $2 billion. Benchmarked against the company’s market capitalization of about $70 billion, the implied forward P/FCF is a proud 35x.

Investor Takeaway

CrowdStrike is expected to capture a substantial share of the booming demand for cybersecurity, with analyst consensus projecting a robust ~30% YoY topline growth in 2024 and 25% in 2025. Despite these positive growth indicators and CrowdStrike’s impressive free cash flow margin – generating approximately 36 cents for every dollar of incremental sales – the company’s valuation at 22x EV/ Sales and a 103x EV/EBIT raises concerns. As a function of both commercial momentum and valuation, I assign a Hold recommendation.