CrowdStrike Impressed Investors

In this podcast, Motley Fool senior analyst Asit Sharma discusses:

• Shares of CrowdStrike rising as the cybersecurity company closed out the fiscal year on a strong note.
• Taking the "basket approach" to cybersecurity stocks.
• Funko's surprising solution to having too much inventory.

Motley Fool content strategist Mary Long talks with BlackRock managing director Gargi Chaudhuri about the case for bonds and some economic predictions her team made in 2022.

To catch full episodes of all The Motley Fool's free podcasts, check out our podcast center. To get started investing, check out our quick-start guide to investing in stocks. A full transcript follows the video.

This video was recorded on March 8, 2023.

Chris Hill: Can I interest anyone in $30 million worth of bobblehead figures? Details coming up. Motley Fool Money starts now.

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I'm Chris Hill. Joining me today: Motley Fool Senior Analyst Asit Sharma. Good to see you.

Asit Sharma: Chris, good to see you.

Chris Hill: Let's start with cybersecurity, shall we?

Asit Sharma: Sure.

Chris Hill: Shares of CrowdStrike are up a bit today after fourth-quarter results were better than expected, and CrowdStrike's free cash flow appears to be flowing to the tune of $200 million in the quarter. But what did you think?

Asit Sharma: This is a company that really is making a lot of hay out of its subscription business. It is deep into the enterprise in the cybersecurity business, keeps selling more to very large customers and more of the components of its Falcon platform. The Falcon platform is this big, bad platform that's informed by a lot of AI, and it handles trillions of data points. The more big customers use it, the more they want to buy in terms of modules.

I want to cite this one statistic from the conference call. Subscription customers that are buying five or more, six or more, or seven more modules, those customers grew by 52%, 62%, and 75% year over year, respectively.

This is what is informing these big numbers out of CrowdStrike, not just this quarter but in previous quarters. This quarter, they showed annual recurring revenue growth of 48% year over year. As you mentioned, they had that monster-free cash flow of $209 million. You need to pay attention to that because on the books, GAAP earnings are still negative, although when they adjust their operating profit, that is a positive number of $96 million during the quarter.

I also want to note here that they've got not just a foothold in the enterprise, but they're selling more and more to small and medium-sized businesses, clocking in at a total of more than 23,000 subscription customers total this quarter.

Chris Hill: One of the things we've talked about in the past is for a lot of people, cybersecurity is something that is obviously important. We've talked before about how businesses, when they're looking to cut expenses, they're probably not cutting back on cybersecurity. But some people like to take a basket approach to investing in a particular industry. Do you think CrowdStrike is one of those that either needs to be in the basket or is at least worth considering for a basket of cybersecurity stocks?

Asit Sharma: Chris, for years, I shied away from the cybersecurity industry just because it changes so rapidly. To me, watching these companies for the last couple of decades, it used to be almost like what's the point here? The technology changes. Companies that are strong today, they start to fade, and new ones come on to the surface. It seems like such a hard industry to invest in.

But I think this latest generation of companies is worth buying and holding. To me, CrowdStrike is one that should be in your basket.

The reason why is that it's not doing anything that is particularly unique in the areas in which it excels, like zero-trust security, endpoint security, but what it does better than almost any other company is offering these products and services in a way that's very lightweight. The agents are very lightweight. There's not much of a load on your system when you start using their platform. They make it very simple to come in at an extremely low cost, so they're great at land and expand. Meaning thereby a small division in a company can start using their products and it can mushroom through the organization.

The other thing that differentiates this company from many of its competitors is its successful reliance on channel partners. That looked to me like maybe a suspect way to market products and services. I always believe like a direct sales force that's going in and getting enterprise businesses the way to go, but here, they proved me wrong. I think 83% of their revenue came from channel partners. These aren't all small and obscure companies. They've got agreements with Dell now, who is promoting their products through its ecosystem.

I think strategically, the way they sell their products, and also just the lightweight nature of the products, the ease at which they can then be picked up by other divisions within an organization is providing some separation between this company and some of its competitors.

Chris Hill: Am I correct in assuming that the economics of selling through channel partners is not quite as good on the margin line for CrowdStrike than what they're doing in terms of in-house selling? Obviously, as you said, 83% from a volume standpoint. That's fantastic, but I'm wondering if the economics are just slightly worse?

Asit Sharma: Always, when you can build an efficient direct sales force, if you're selling into large corporate clients, that's the way you want to go. That's a higher-margin way to sell. But if you are, I don't want to say spraying, because they're doing something a little more sophisticated than that, but let's say you're aiming for all sizes of the market. Do you want the small and medium-sized businesses? You want the slightly larger ones, you want, Fortune 500 companies, then it makes sense for some portion of your business to be engaging with resellers channel partners.

Once you get really high volume, the economics start to balance out a bit. Yes, if you can't scale, it can be a disastrous strategy to take.

But I will note also that other competitors that we associate in this space, maybe Fortinet is one that we can look at, also used channel partners. It's part of the way these companies build their approach to grabbing their fair share of the market, it helps them scale much more quickly.

Chris Hill: You and I have talked on the show before about Funko Pop, which is the publicly traded company best known for pop culture figures with the big heads. Like many companies, Funko Pop is not immune to inventory problems. Unlike other companies, however, they appear to have a, well, a solution that is grabbing headlines, which is Funko Pop decided to just throw away $30 million worth of bobbleheads.

That just immediately conjures up the image of how many bobbleheads is that? I've been in stores, seen Funko Pops selling for anywhere from $5 upwards to $25, $30. But I guess the management team ran the numbers and figured out, you know what? This is actually going to be more expensive for us to store them somewhere than to just throw them away.

Asit Sharma: What an agonizing decision. It's especially agonizing if you're a shareholder of Funko, because the company can rebound from this inventory snafu that actually has its roots in the previous couple of quarters, but it just feels so tough to think about throwing away product. That's obviously not great for the environment.

I'll get into a little bit about why the decision is made to throw this stuff away. But just to give you a bit of history, or to refresh, because we've chatted about this. Funko, for many years, was run very successfully from a growth perspective. During the tail end of the pandemic, they miscalculated on their inventory. The former CEO, who hadn't been in that seat very long, was moved to the present position.

The former CEO now is running the show again. He stepped back in, I think as of December, that's Brian Moriarty. He is really good at understanding inventory levels and tying that to projected sales. I don't have much doubt that he'll rectify these issues.

I should point out that Funko itself, while it's facing this challenge and growth was flat in the last quarter, still has a lot that's going well in the business. They have a European division called Loungefly, which specializes in these bespoke backpacks, that's growing at a double-digit rate and really making up for some of the deficiencies on this inventory side of the business.

Nonetheless, here's where this company is different than, let's say, I don't know, a company that's selling modular couches. If you overshoot your projections, right, you can hold stuff in inventory for quite a while. Styles don't change that much, but if you've predicated the value of your product on a collectibles basis, that this is rare and unique, if you end up with too much inventory, you can't dump out on the market because it decreases future sales value. It decreases the value in hands of people who collect these. For that reason, they couldn't even donate these to charity for fear of that flooding the market eventually.

There's one more dynamic behind this story in that Funko had moved to a really brand-new great distribution warehouse in Arizona, which was only meant to run at 80% capacity. When the products stopped selling so quickly, with all the supply chain kinks and interest rates spikes, inflation spikes late last year, that distribution center went up to 100% capacity, so they had to shift product into containers and storage spaces and it was really bleeding money on the inventory line.

They're working that back down to 80% again of capacity, but I understand that the inventory write-down is going to be somewhere between 30 million and 36 million bucks. I was chatting with an analyst yesterday at the Motley Fool and she shared a viral TikTok, which makes this whole thing seem so sad and in which a young person's explaining how these collectibles are going to make their way into the landfill.

This is the impact of a decision where if you're off by an order of magnitude one quarter, it can be really hard on your brand too. I have to think that they considered all the options and this was the only viable one to stop that cash bleed, because they are taking a little bit of hit on the brand. I think Funko will recover, but again, it hurts to see this on all levels.

Chris Hill: Well, for spring break this year, my son and I are taking a road trip north, so we'll see if we can hit Newbury Comics somewhere on the way and maybe help move the inventory along. It's a fascinating story and much deeper than just the headline in the imagery of $30 million worth of Funko Pop dolls ending up in a landfill. Asit Sharma, always great talking to you. Thanks for being here.

Asit Sharma: Thanks so much, Chris, this was a lot of fun.

Chris Hill: Have you noticed how six months ago, there was a lot of talk about a recession coming in 2023, and here we are now six months later, and it still feels like a recession is probably six months away? Mary Long caught up with Gargi Chaudhuri, a managing director at BlackRock, to check in on some economic predictions that her team made last year and the case for bonds right now.

Mary Long: Late last year, your team published a 2023 investor guide, and you also just recently released some commentary that called January's market gains a false spring. What were the top-line takeaways in the 2023 investor guide, and how are those predictions holding up as we near the end of the first quarter?

Gargi Chaudhuri: One of the things that we had talked about in the January 2023 guide -- which, by the way, it was written at the end of November -- was just this concept that interest rates would stay higher for a longer period of time. That the Fed, as we know, is raising interest rates and they're doing so because inflation is quite high, it's higher than we want it to be. It's higher than the Fed themselves want it to be.

Unfortunately for many of us, because we feel it in our wallets, unfortunately, the view was that inflation would remain a little bit stickier than perhaps the market was expecting, at least back in November 2022.

As it turns out, as we think about what's happening today in the markets, interest rates are higher. In fact, they are higher today than they were in about a month ago, about two months ago. And the other thing that we're recognizing is that inflation is certainly also remaining a little bit stickier than we had expected. Both of those are coming into fruition like we had thought.

I would say the one area where we had expected a little bit more of a repricing, if you will, where we'd expected some weakness was the equity market, where we had thought that certain areas of the equity markets would do better than others. So far, as of now beginning of March, the market has done the stock market has done much better than we would have thought.

Mary Long: Everyone talks about this possibility of a recession, and even your team and the investment guide, I think, said that a recession this year is almost a certainty. It feels like this conversation of a recession is something that for the past year, everyone in financial media has been talking about. From where you're sitting, where is this recession, and why does it almost always seem like it's another six-ish months ahead?

Gargi Chaudhuri: Yeah. When we were, again, looking at the data in November, the expectation that we had that inflation would stay stickier at above 3% for the entirety of 2023. As a result of that, the Fed would have to raise rates. At that time, we thought it was closer to 5%. Now, we're realizing it could actually be a little bit higher than that, maybe closer to 5.5%, and as a result of that, the Fed would have to dampen demand and the economy. That's what they want to do. They want to dampen demand and the economy so that inflation slows down, so that we just slow down, so the job market slows down just a little bit. All of that, we felt, was going to lead to a recession.

Now again, this is where the humility comes in, and this is where the thinking about your framework comes in. We have to think about, what is the data that we're getting? What is the data that we've gotten so far on consumption? On inflation? On durable goods? On retail spending? And what does that point to in terms of the shape and the health of the economy? And rethinking whether it be perhaps either got it wrong or early, which is I suppose another way to say wrong. But as the data changes we have to challenge ourselves to change our mind if that is the appropriate thing to do.

For now, given that, to your point, we did call for a recession to be a foregone conclusion for 2023. The data for January and February does not indicate that at all. The data for January and February so far looks at a very healthy U.S. economy and actually a stronger European economy as well.

Now, the flip side of that is with the Fed keeping rates at a higher, in fact even higher than what we had originally thought level for longer means that there will be slowdown, and I think the slowdown will happen a little bit later than what we had originally thought. It's possible, and I'm slowly opening my mind to the fact that it is possible that we maybe achieve a soft landing, that we get by without a recession.

I will say that we weren't acknowledging that before and right now it does appear that certain sectors, even the manufacturing sector, certainly the consumption sector, is doing a lot better. I think we have to trust our process and wait for more data to come out. For right now, it's a recession delayed, not a recession for foregone. But we wait for the data to tell us otherwise.

Mary Long: I like that phrase, "a recession delayed, not a recession forgone."

I want to pivot a little bit. Another one of the big takeaways from that investor guide was an acronym, BARB -- bonds are back.

Gargi Chaudhuri: Yeah.

Mary Long: Stocks are our bread and butter here at The Motley Fool, so -- and I know this is a big ask -- can you give us a quick class in Bond Markets 101?

Gargi Chaudhuri: Love that.

Mary Long: If I'm an individual investor whose portfolio is primarily stocks, but I'm thinking about reallocating in this high-interest-rate environment or want to explore new asset class, what do I need to know to dive into the bond market?

Gargi Chaudhuri: Absolutely, it would be my pleasure, especially because I think that what you are able to own in bonds right now is so attractive compared to any time in the most recent history. I would imagine that most of the listeners of your show haven't invested 20, 30 years ago, when bond yields were significantly higher than here. I think by looking at a cohort of investors that are gravitating toward the equity markets in a world where we used to use the acronym TINA -- there is no other alternative -- and therefore, you had to go to equity markets to own your return.

That's where this other new acronym comes in, which is BARB, which is bonds are back. And the reason that we talk about BARB, the reason that we talk about bonds being back is that for many years, especially since 2020, when the Fed cut rates all the way to zero in response to COVID pandemic to rebuild, invigorate the economy. You weren't really earning anything owning bonds; you weren't really earning a coupon.

The point of owning bonds -- and this is going back to your first ask, Mary. The point of owning bonds is every six months you will earn a coupon. You know what that coupon is going to be and at the end of the period of the bonds. So you can own a bond for two years, 3 years, 5 years, 20 years, you can own different types of bonds. The safest bonds that are backed by the full faith of the U.S. government are called Treasury bonds.

Then you can have different credit bonds that are issued by corporates and depending on how highly ranked the corporation is, those types of bonds are called different types of bonds that can be high-yield bonds, or they can be investment-grade bonds. Bonds of other countries are also available to us.

If you're looking at emerging markets -- so I'm from India. If you're looking at a bond from the Indian government, that is certainly available to you, but it will have probably a little bit more volatility. You might ask for a higher coupon or a higher yield to invest in certain types of bonds that are not as safe.

The whole idea of investing in bonds is that it's the safer allocation in your portfolio. How safe depends on which bond you allocate to. The idea is you put your money, you get a coupon and at the end of the period of time that you buy the bond for, you get your principal back.

Now, for the longest time, as I mentioned earlier, Treasuries were yielding absolutely close to zero, and even if you were sitting in 10-year Treasury, so your money was locked up for 10 years, you were only earning about a little over 1%. Very, very low level of interest rates or income from your Treasuries. Then if you took a little bit more risk, so if you bought emerging-market bond, or if you took a bond of a corporation that wasn't as safe as what the U.S. is perceived to be, you could earn what we call a little bit more risk premium on that, a little bit of spread on that, but still, they were very low.

Now fast-forward to today, where if you own a bond for the next three -- or it's called a bill, actually. But if you own securities where your money is locked up only for three months or six months, or even one or two years, you're actually earning close to 5%.

We haven't been in that environment for about 16 years, since the previous financial crisis. You can not only be in a very safe part of the market with Treasuries being backed by the government, but you can also earn a coupon on an income that is pretty hefty at 5%. That's why we say bonds are back as a driver of income in your portfolio, especially in a world where we think equity markets can, again, have a little bit of volatility.

By no means are we saying that you should not invest in equities. Always be investing, but also reconsider bonds in a world where you can own 5%, locking up your money for a very small or very short period.

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Chris Hill: As always, people on the program may have interest in the stocks they talk about, and The Motley Fool may have formal recommendations for or against, so don't buy or sell stocks based solely on what you hear. I'm Chris Hill. Thanks for listening. We'll see you tomorrow.