CrowdStrike's First Public Earnings Release Confirms It's Off to Hot Start

CrowdStrike Holdings (CRWD +1.25%) has been one of the hottest initial public offerings (IPOs) of 2019. After initially pricing itself at $34 a share in June 2019, the stock has more than doubled and is showing no signs of slowing down after its first quarterly report as a public concern (out last week).

Make no mistake: Even with revenues more than doubling during the fiscal 2020 first quarter (the three months ended April 30, 2019), the cybersecurity start-up is an expensive investment. The current valuation is assuming that the company's torrid pace -- as well as the cloud-based security software industry's growth -- will continue for the foreseeable future. For the right investor with the proper expectations, though, there's enough here to at least give the stock a look.

The quarter by the numbers

When CrowdStrike went public, the allure was that the cloud-native software business was going at a triple-digit pace -- up 110% in 2018 over 2017. The lofty pricing fetched for the stock assumed that would continue. It did.

Pp = percentage point. Data source: CrowdStrike Holdings.

Within the grand total, subscription revenues (made from recurring software-as-a-service access to CrowdStrike's platform) were up 116% to $86.0 million and gross profit margin of 72.4%. It's likely that those gross margins will continue to improve, too, as once the cloud platform creates a module for a customer and pays for its up-front costs, the data from it is reused many times over. (More on that in a moment.)

The only blight here is that, though they are improving, losses are still steep. Much of that is due to the high rate of operating expenses as CrowdStrike funnels cash into expansion efforts, but the good news is that expenses are growing far more slowly than revenue. Thus, profits won't be elusive once management decides it's time to start worrying about such things. And the recent IPO raised $659 million in net cash, giving the business ample room to maneuver itself in the years ahead.

Nevertheless, for investors looking for a way to value the stock, there's no easy way to do so without any bottom-line black. Price to sales (market cap divided by the last 12 months' revenue) is one imperfect way to take a stab at it. But since shares were up double digits after the first-quarter report, the surge in revenue isn't helping that metric much (price to sales sits at an incredibly rich 55.0 as of this writing). For the sake of comparison, fellow cloud security outfit Zscaler (ZS 0.80%) trades for 38.1 times sales, although revenues grew "only" 62% during its last quarter.

Image source: Getty Images.

The CrowdStrike advantage

As swimmingly as the first quarter may have gone, CrowdStrike's torrid growth and the ludicrous stock price might all sound too good to be true. And for the risk-averse investor, they certainly might be. However, knowing a few things about this cybersecurity business model will help you in making that call.

First, CrowdStrike and other cybersecurity upstarts like Zscaler and Okta (OKTA 1.11%) were built from the ground up on a cloud computing platform versus an older legacy software system. For this reason, the security software is scalable to all of its current and future customers' needs, and updates happen in real-time across an organization. Because CrowdStrike monitors and collects security data about threats and possible weaknesses in the cloud, the more customers there are, the more effective the software becomes as it learns and adapts to threats. It's a powerful business model that is winning over hundreds of new enterprise clients -- there were 543 net new subscription customers in the first quarter alone.

Second, CrowdStrike's addressable market is a fast-growing one within the cybersecurity industry. The company is adding new services to its suite, but its specialty is endpoint security -- specifically safeguarding the hundreds of millions of "endpoints" in an organization ranging from computers and laptops to smartphones to container and remote asset tracking. The number of connected devices out there is growing by hundreds of millions a year. As that trend continues, the increasing number of devices in need of lockdown provides a strong wind at CrowdStrike's back. The company estimates its addressable market is worth $24.6 billion in 2019 and will grow to $29 billion in 2021.

Between adding new device protection and new software security services, CrowdStrike is getting a huge bump from its existing customers. In 2018, the dollar-based net retention rate (the average extra spending from existing customers) was 147%, implying nearly 50% growth in what existing customers spent with CrowdStrike. Management said its benchmark for the metric is 120% or higher, a bar that was cleared -- though the specific number wasn't given -- in Q1.

Between new customer growth and expanding relationships with existing ones, CrowdStrike expects another massive rate of growth in the year ahead. Full-fiscal-year 2020 revenue is expected to be $430 to $436 million, representing at least a 72% increase over last year. Losses should continue to pile up, expected at $113 to $110 million on an adjusted basis, but the bottom line is improving (operating losses totaled $137 million last year). Also, management did admit during the earnings call that it is forecasting prudently, so these figures may come in better than stated.

In short, the bottom line looks horrific, but this is a company sacrificing short-term gains for maximum growth and profit later. As such, the stock will be a volatile one -- it's not going to continue going straight up like it has been -- so investors who don't have the stomach for a wild ride or the ability to purchase small blocks of shares to build a position over time should steer clear. For those with time to wait it out, though, this cybersecurity upstart looks like it has a bright future.