Why the Outlook for CrowdStrike's Business Remains Positive but for Its Share Prices, Less So

Fast-growing cybersecurity stock CrowdStrike Holdings (CRWD 0.14%) is now underwater -- at least from its public debut price from the summer of 2019. Shares did surge more than 70% from their IPO pricing on the first day of trading and continued to race higher from there as investors were attracted to the triple-digit revenue growth disclosed in company's prospectus. But reality has since set in, and shares are currently at $48 and change, and most investors who bought in post-IPO are sitting on an investment loss.

Though results have begun to moderate, revenues still grew at an 88% clip (98% for subscription-based revenue) during the third quarter of fiscal 2020 (three months ended Oct. 31, 2019) -- again easily topping management's conservative guidance. The outlook remains positive, but valuation remains high in spite of shares coming back down to earth. Barring sales picking up steam again, CrowdStrike shares could have a couple more tough quarters left before resuming their rise.

Image source: Getty Images.

A great year for an IPO

For all the guff the stock has taken lately, it's important to remember one of the reasons a company decides to go public (besides giving early private investors an option to exit): to raise cash. From that standpoint, CrowdStrike's IPO this year is still a success no matter where shares wind up finishing in 2019. The endpoint security company ended Q3 with $744 million in cash on the books compared with $88.4 million at the end of its last fiscal year. That provides years' worth of money at the current burn rate as CrowdStrike continues to maximize its revenue potential now in lieu of profits.

Pp = percentage point. Data source: CrowdStrike Holdings.

The bottom line is pretty ugly, though, huh?

Do bear in mind that operating expenses include $55.6 million in stock-based compensation to employees, so cash expenses are at least lower than revenue is. As CrowdStrike expands, those expenses are also growing at a slower rate than revenue. That's good news for eventual profitability. However, even when making adjustments for noncash and nonrecurring items, CrowdStrike is still running in the red -- although Q3 was free cash flow positive at $7 million. Most investors just aren't going to be comfortable with a business like this, and especially with it trading at 20.7 times trailing-12-month sales.

Lockup periods, moderating growth, and expanding services

However, for those who can stomach the twists and turns, have the time to wait, and can make periodic purchases and build up to a larger position, CrowdStrike remains a promising business. New customers (net 772 in Q3, bringing the total count to nearly 4,600) continue to flock to its endpoint protection platform -- think laptops, smartphones, cameras, sensors, just about any of the hundreds of millions of new network-connected devices coming online every year. But CrowdStrike knows that a single specialty will eventually run its course, and many customers are looking to simplify their security operations by using fewer vendors.

To that end, the company launched a virtual firewall product in early Q4 to expand its scope in keeping businesses safe. More product additions should be in the cards soon. CrowdStrike launched its Falcon Fund to invest in and support early-stage start-ups using its platform. It also has an app store through which developers can build and launch solutions based on the company's security suite.

However, results continue to slow down in the interim. Q4 guidance calls for revenue growth of 69% to 72%, which would bring full-year revenue in the range of $465 to $468 million. That would make for an 86% to 87% increase for fiscal 2020, nothing to balk at but a significant slowdown from the 110% rate in fiscal 2019 -- although it's worth bearing in mind that management has significantly beat its own guidance thus far.

All of this is to say that in spite of an impressive business run in its short history as a public concern, there could continue to be some disconnect between actual results and CrowdStrike's stock performance given the high valuation. The lockup period on insider sales of shares expired early in December 2019, which could also put some more downward pressure on the stock's price in the short term.

Nevertheless, I maintain that this fast-growing cybersecurity upstart is worth keeping an eye on and picking up a few shares on a periodic basis -- if you have at least a few years to let things play out. The company is making waves and gaining market share and is well funded to continue disrupting the current security industry landscape. Just fully expect a very bumpy investment ride along the way.