Description
We are short shares of Crowdstrike (CRWD). We nailed the numbers on both PANW and ZS, and firmly believe CRWD is setting for the biggest miss.
NUMBERS DON’T LIE
A closer look at the numbers across the cybersecurity sector reveals concerning trends.
Overall demand for Cybersecurity is SLOWING. Earnings across the sector have ranged from uninspiring to downright bad.
- Fortinet (FTNT) posted upside to 4Q billings (+8% Y/Y vs. Street’s -5% Y/Y), but only after two consecutive quarters of billings misses (and thanks to a few windfall deals that either slipped from prior quarters or were pulled in from future quarters). FTNT’s forward guidance was less inspiring, calling for ~2% billings growth in FY24—suggesting that the security demand environment will remain weak for the next year (and potentially beyond).
- Palo Alto Networks (PANW) missed billings for the second quarter in a row and proceeded to cut its FY billings outlook by $600M – implying 10% Y/Y growth vs 17% prior. The company announced strategic changes to its go-to-market, which are expected to result in further headwinds in FY25. These changes include giving away products that are competitive with both ZS and CRWD, and likely to cause deflationary pressures in both end markets.
- Zscaler (ZS) billings growth decelerated 700bps Q/Q on a 300bps easier comp. Beneath the surface, numbers look far worse given the growth in Long-Term Deferred suggests ZS was forced to discount more aggressively on multi-year deals to "manufacture" billings growth. 3Q billings were guided below Street and point to another 600bps deceleration in growth. 4Q numbers suggest a hockey-stick rebound, which many investors are likely to question.
CrowdStrike (CRWD) numbers are the most egregious of the group. Over the last two quarters, CRWD’s net new ARR (Annual Reccurring Revenue) has narrowly exceeded management’s guidance. In fact, 3Q results missed guidance for net new ARR after backing out the ~$6M in inorganic contribution from Bionic (per UBS).
The limited upside in CRWD numbers is more concerning when considering that CRWD is uniquely benefitting from a concentrated period of 3Y COVID renewals this year. In FY25, that tailwind will go away. Despite this fairly obvious headwind, consensus is modeling CRWD’s net new ARR to grow ~10% in FY25 and ~12% in FY26. To put this in perspective, this would require CRWD to add the most ARR in one year by any security company, ever.
"SPENDING FATIGUE"
Why’s this happening now?
Simplistically, enterprises have invested a significant amount in Cybersecurity over the last 3Y and budgets are no longer growing at the same pace. In some cases, they’ve overspent and are rationalizing products or consolidating around vendors to reduce Total Cost of Ownership.
To illustrate, during Palo Alto Network’s (PANW) recent earnings call, the CEO told investors that “despite the many demand drivers [they’re] seeing, [they’re] beginning to notice customers are facing spending fatigue in cybersecurity.”
PRICE WAR = KNIFE FIGHT
In an attempt to offset weaker firewall demand and firewall-attached subscriptions, Palo Alto is embarking on an aggressive campaign to take share from other security vendors. This includes giving its software away for free to stimulate new customer adoption. Based on PANW’s recently published marketing documents, the most aggressive target appears to be CrowdStrike. For example, Palo Alto is giving away 5,000 seats for free, and providing professional services credits for any existing CRWD customers who are willing to make the shift (links to documents below).
While it’s possible that many customers will stick with CRWD, those who do are likely to use PANW’s pricing as leverage in renewal discussions, adding significant risk to an already aggressive net new ARR outlook.
VALUATION
CRWD currently trades at 53x CY25 Street FCF vs 2Y average of 31x. Given the SIGNIFICANT LIKELIHOOD of downward revisions, we believe the downside case for shares is $220.
I do not hold a position with the issuer such as employment, directorship, or consultancy.
I and/or others I advise do not hold a material investment in the issuer's securities.
Catalyst
Earnings
Updates on PANW's competitive wins