The world recently witnessed one of the most extensive IT outages in modern history, affecting approximately 8.5 million Windows devices according to a Microsoft spokesman. A routine update aimed at enhancing security on Windows enterprise forced many businesses to cease operations as Windows devices displayed the infamous "Blue Screen of Death".
This event has had a significant impact on the stock of cybersecurity provider CrowdStrike CRWD 0.00%↑, which has seen its shares drop double digits for two consecutive days. On Monday, CrowdStrike shares fell another 13%-ish to $269 after an 11% drop on Friday, marking a 32% decline from its early July all-time high (ATH). The stock slightly recovered during Tuesday’s trading session.
Outlining The Structure of This Post
In this article, I'll explore whether this decline in what is undeniably a high-quality stock represents an interesting buying opportunity, seeing it as a temporary setback, or …
… whether the reasons to stay away outweigh potential gains.
By asking, "What would Buffett do?", I will try to frame the following discussion around two prominent quotes from Warren Buffett that, however, cannot BOTH AT THE SAME TIME describe the situation at CrowdStrike accurately - think of them as two different ends of the "Buy CrowdStrike Now” continuum?
1. "A great investment opportunity arises when a marvelous business encounters a one-time, huge, but solvable problem."
2. “It takes 20 years to build a reputation and five minutes to ruin it.”
CrowdStrike – A Golden Opportunity?
Let's start with the first quote:
Let me start with some high-level thoughts on this quote. I think Buffett is as always spot-on! Stock market participants tend to be very short-term focused and they hate uncertainty like vampires hate sunlight!
However, it is only natural that companies occasionally face significant setbacks. The key is assessing their ability to recover and bounce back from such issues. If they can successfully manage to do so, the short-term setback might have created an opportunity for outperformance.
It’s not hard to find examples of companies that have faced significant setbacks but managed to recover and eventually outperformed over a certain period. A few that came to my mind were:
Chipotle Mexican Grill (CMG 0.00%↑): Chipotle faced a major crisis between 2015 and 2016 due to food safety issues, including E. coli and norovirus outbreaks. As a consequence, the company overhauled its food safety practices and revamped its menu and marketing strategies. Over time, it regained customer trust and saw its stock price and sales recover significantly.
Cruise Line Stocks During the Pandemic: The COVID-19 pandemic severely impacted the cruise industry, with widespread travel bans, cancellations, and financial losses. Major players like Carnival Corporation (CCL 0.00%↑), Royal Caribbean Cruises (RCL 0.00%↑), and Norwegian Cruise Line Holdings (NCLH 0.00%↑) saw their stock prices plummet. But as travel restrictions eased and vaccinations became widespread, the cruise industry began to recover. Companies implemented stringent health protocols and resumed operations, leading to a rebound in bookings and stock prices.
Apple Inc. (AAPL 0.00%↑) - Declining China Sales: Apple faced declining sales in China due to increasing competition from local brands like Huawei and regulatory challenges. Additionally, geopolitical tensions and trade disputes between the U.S. and China added pressure to the stock. Nowadays, Apple is not only relying on iPhone sales. Apple diversified its product line, focused on services and wearables, and strengthened its ecosystem. It also made strategic investments in China and other emerging markets. These efforts helped Apple stabilize its sales and maintain its position as a leading tech company.
Netflix (NFLX 0.00%↑): In 2011, Netflix faced a major backlash after it announced a price increase and plans to separate its DVD rental and streaming services. The move led to a significant loss of subscribers and a sharp decline in its stock price. Eventually, Netflix reversed its decision, improved its streaming service, and invested heavily in original content. The company recovered subscriber growth and expanded globally, becoming a dominant player in the streaming industry.
So what about CrowdStrike? The setback is more than apparent. But what does CrowdStrike have on its side that could lead to a swift recovery? Here are three “bullish” arguments:
1. CrowdStrike Is Founder-Led and Offers a Quality Product!
CrowdStrike, led by founder George Kurtz, immediately took responsibility for the issue, apologized, isolated the problem, and worked on a fix. This level of accountability and action is crucial for recovery.
Moreover, CrowdStrike is simply a high-quality, high-margin, high-retention rate business with a long runway ahead:
Finally, in my investing mentorship program, I share a comprehensive “moat framework” that I have developed over the years. I refer to CrowdStrike as an example of a company benefiting from “data network effects”:
Similarly, the biggest data security companies (such as global cybersecurity leader CrowdStrike) can thrive in an environment fueled by network effects. As their customer base expands, they accumulate a richer well of data on cyber threats. This data serves two crucial purposes. First, it allows them to identify new attack methods and vulnerabilities much faster as some data security companies foster platforms where clients can share information about encountered threats. Imagine training a security system on an enormous dataset of attempted intrusions - the more data points, the better it recognizes and defends against future attacks. Second, this data feeds into the development of superior threat detection tools and algorithms. The more threats the network encounters, the more sophisticated the security company's defenses become. The company with the most extensive data can offer the most comprehensive security solutions, giving them a clear edge over competitors. Organizations seeking the best possible protection are naturally drawn to these leaders in threat detection. This influx of new clients further expands the data pool, creating a continuous cycle that strengthens the position and offering of the biggest players.
2. Security Breach vs. Human Error
Importantly, the issue was not a breach in their products but a glitch related to a product launch/update. This distinction is vital as it does not reflect on the efficiency of CrowdStrike's cybersecurity products.
Hence, CrowdStrike's reputation for best-in-class endpoint security may remain intact over the long term despite this incident.
3. Proportion of the Outage
Lastly, bull would argue that the scale of the outage is being overblown. According to Microsoft’s David Weston, only 8.5 million Windows devices were affected, less than 1% of the global Windows installation base.
So while there are risks and unknowns, CrowdStrike's stock has the potential to recover over time, given its strong product offering and leadership team.
A Potential Value Trap?
I used the term “value trap” for this section of the post for lack of a better term. I think the term isn’t really fitting quite frankly as CrowdStrike’s valuation is not really looking particularly cheap! (we’ll discuss it in a moment)
But the idea I wanted to get across is that some investors may be lured into buying CRWD 0.00%↑ simply because the stock is down a significant % from a previous high.
If you consider the illustration below, however, attractive investment opportunities arise if the share price is down significantly, while the intrinsic value is constant or increasing. Once the “gap” gets large enough, you want to be buying.
However, a declining share price alone is not sufficient. Imagine a company whose share price is down 20% from a previous high, but the intrinsic value is down 30%.
Similarly, a company’s stock may simply have been way overvalued in the past. The share price may be down 50% but still above the intrinsic value of the business.
These factors should be considered in the context of CrowdStrike. With that being said, let’s consider Buffett's second quote:
Here are two “bearish” arguments regarding CrowdStrike’s stock:
1. Reputation and Trust
The outage has undoubtedly damaged CrowdStrike's brand reputation. With critical services like airlines, retailers, and hospitals affected, the market's reliance on CrowdStrike was highlighted in a negative light.
This incident could prompt IT teams to diversify their cybersecurity providers, potentially benefiting smaller vendors?
As Buffett said, it takes years to build trust but only moments to destroy it. How permanently CrowdStrike’s image was damaged remains to be seen.
2. Economic Impact
As explained, the impact of the events on $CRWD’s share price relative to intrinsic value development must be assessed.
I think the two primary impacts on CrowdStrike’s intrinsic value (i.e. the impact on CrodStrike’s cash-generating capabilities) are:
Liability Litigations: Lawsuits are inevitable as customers across the world lost BILLIONS in revenue, had to manually address the issue, and spent extensive time and resources to simply restore operations.
Impact on Business Going Forward: As discussed, CrowdStrike’s best-in-class brand took a hit! As a result, churn rates, customer retention rates, and potential discounts to existing and new customers could negatively affect future business. There is also the risk of customers asking for refunds or canceling contracts.
Valuation Concerns
CrowdStrike’s stock is not as cheap as it may seem. Sure the stock is down some 30% from a previous high, but …
Despite the recent decline, CrowdStrike's stock has roughly the same YTD return as the equal-weight S&P 500, indicating room for further decline.
Also, not too long ago, CrowdStrike was trading below $100 a share. Ever since, CrowdStrike’s stock had a massive runup.
CrowdStrike’s stock, even after a 30% drawdown, remains expensive! It is trading at very high earnings …
… and revenue multiples.
Arguably, CrowdStrike is still "priced for perfection" and the recent incident is anything but perfect business execution.
If you combine the VERY high multiple the stock is trading at with the SIGNIFICANT uncertainty going forward, you don’t end up with an appealing, no-brainer investment case!
"If a company's future cannot be predicted, it cannot be valued." (Warren Buffett)
I believe the unpredictability as well as the high valuation pose significant risks which is why I stay on the sidelines.
In fact, I believe it will take several quarters to fully understand the financial impact, and investors should closely monitor upcoming earnings calls for more insights.
As always, thorough due diligence and careful consideration of all factors are essential before making investment decisions!
DISCLAIMER: I don’t own any CrowdStrike shares. I generally don’t short stock.