By Christopher Gannatti, CFA
We recently held a Working hours webinar on disruptive growth megatrends. During the audience poll, “geopolitics” was an important topic. Looking at global investment flows to different megatrend investment vehicles, cybersecurity was also a huge topic.1
However, despite all the attention people are giving to cybersecurity, the performance of companies’ stock prices has not been great.
Looking at the photo and the landscape, we notice:
- Much attention has turned to cybersecurity following the Russian-Ukrainian crisis. Microsoft (MSFT) recently released a report summarizing some of Russia’s very real attack efforts against Ukraine and other NATO members.2
- The way cybersecurity is done has evolved, especially with the COVID-19 pandemic and the need for many people to access all kinds of data from anywhere. Many of the companies offering these innovative solutions are newer and may have only recently entered the public markets. As they look to grow, they may have revenue, but they may not yet have positive cash flow or profits.
- The macroeconomic backdrop operates independently of any specific cybersecurity concerns – to put it simply, inflation is high and central banks are putting policies in place to combat it. A side effect is that new companies that do not yet have positive earnings have been penalized by negative share price performance and lower valuations. The first half of 2022 has seen this approach use a very broad brush, so we believe that at some point it will again be appreciated that a company providing cybersecurity solutions is treated differently than a company providing a more discretionary service. .
Here we can look at some of these different factors in turn.
Microsoft cybersecurity report on conflict in Ukraine so far
A notable factor, which would not have been the case in a previous conflict, is that Ukraine was able to transfer much of its most critical systems and data to the cloud. Microsoft noted the provision of services worth $107 million (provided free to the Ukrainian government) to facilitate this transition to the cloud. The result is that there is no “on-site” physical data infrastructure for Russia to target and destroy.3
Russia is conducting cyberattacks on multiple fronts and operational units4:
- GRU (Main Directorate of the General Staff of the Armed Forces of the Russian Federation): The GRU tries to steal data with phishing attacks through its operation STRONTIUM. Its IRIDIUM operation features some of the types of malware that aim for data destruction. DEV-0586 is also involved in data destruction and influence operations.
- SVR (the Foreign Intelligence Service of the Russian Federation): Operation NOBELIUM extended to Ukrainian diplomatic targets and NATO members.
- FSB (the Federal Security Service in Russia): FSB operations ACTINIUM, BROMINE and KRYPTON are mainly involved in phishing attempts and other data theft.
The report also notes that Russia has been very adaptive in its cyberattacks, for example combining them with physical attacks against specific targets. The right words to describe the efforts made so far might be “strategic” and “deliberate”. To date, there have been no attacks using “wormable” malware like the 2017 NotPetya attack, in which the malware could jump from one computer network to another. The attacks appear to be designed to stay inside Ukraine.
The report also details 128 Russian network penetration and cyber espionage operations outside Ukraine. About half of these government agencies targeted, but mostly the success rate was only 29%. It’s worth remembering that cybersecurity attacks can be a numbers game, but it’s worth noting that if the world is now fully focused on this, they are able to mount at least a somewhat effective defense, at least until now.
Let’s look at CrowdStrike
CrowdStrike (CRWD) is a well-positioned company for today’s cybersecurity environment, helping with cloud security and endpoint protection. In its latest quarterly results, CrowdStrike actually raised its full-year guidance. Like many other security vendors, CrowdStrike said it had seen no clear evidence that customers were going to reduce their security spending. When articles are written and analyst coverage is relayed, it is usually very positive and focused on a strong long-term story for CrowdStrike.5
So where is the disconnect coming from, especially with such a difficult share price performance in 2022? While we probably can’t know for sure why a stock is trading the way it does, we can see that CrowdStrike has tended to have a very high valuation relative to earnings or revenue. Perhaps the long-term growth story can support this, but in the current macro environment, exposure to a company with such high multiples can lead to short-term volatility, regardless of the product or the service provided.
Conclusion: SaaS Companies Should Negotiate Based on the Problem They’re Solving
It’s amazing how competitive the Software-as-a-Service (SaaS) space can be. Consider Shopify (SHOP) – a great company. Their reward, at least one of them, for being a great e-commerce platform is to compete with Amazon (AMZN) Prime. Think Zoom (ZM) – a household name. Now they can compete with Microsoft Teams, a tall order. It’s great that these newcomers can keep some of the biggest companies in the world on their toes, constantly improving their product offerings.
However, cybersecurity, in our opinion, is a bit different from other SaaS companies. While the specific companies people can work with differ, every company and really every person needs to have some sort of cybersecurity strategy to protect their data and other digital endeavors. Moreover, the space is constantly changing, whether due to the COVID-19 pandemic, the Russian-Ukrainian crisis, or other factors. We think that somehow you need to focus on new companies that offer more advanced solutions. Even though the coming months can be volatile, we like the longer-term case of this megatrend.
For those interested in cybersecurity, consider the WisdomTree Cybersecurity Fund (WCBR).As of 7/7/22, WCBR held 5.35%, 0%, 0%, 0%, 0% of its weight in CrowdStrike, Shopify, Amazon, Zoom Video Communications and Microsoft, respectively.
1 Sources: WisdomTree, Morningstar and Bloomberg. All data as of 3/31/22 from WisdomTree’s Quarterly Thematic Classification Study and subsequent quarterly updates.
2 Source: “Defending Ukraine: Early Lessons from Cyberwarfare”, Microsoft, 6/22/22.
3 Source: Microsoft, 6/22/22.
4 Source: Microsoft, 6/22/22.
5 Source: Eric J. Savitz, “CrowdStrike Posts Strong Earnings, Improves Guidance, But Stocks Slip,” Barron’s. 6/2/22.
Important risks related to this article
Christopher Gannatti is an employee of WisdomTree UK Limited, a European subsidiary of WisdomTree Asset Management Inc.’s parent company, WisdomTree Investments, Inc.
There are risks associated with investing, including possible loss of capital. The Fund invests in cybersecurity companies, which generate a significant portion of their revenue from security protocols that prevent intrusions and attacks on systems, networks, applications, computers and mobile devices. Cybersecurity companies are particularly vulnerable to rapid changes in technology, rapid obsolescence of products and services, loss of patent, copyright and trademark protection, government regulation and competition , both nationally and internationally. Shares of cybersecurity companies, especially internet-related ones, have in the past experienced extreme swings in price and volume that have often been unrelated to their operational performance. These businesses may also be smaller, less experienced businesses with limited product or service lines, markets or financial resources, and fewer experienced management or marketing personnel. The Fund invests in securities included in or representative of its index, regardless of their investment merit, and the Fund does not attempt to outperform its index or take defensive positions in declining markets. The composition of the Index is highly dependent on quantitative and qualitative information and data from one or more third parties, and the Index may not perform as intended. Please read the Fund’s prospectus for specific details regarding the Fund’s risk profile.
Christopher Gannatti, CFA, Global Head of Research
Christopher Gannatti started at WisdomTree as a Research Analyst in December 2010, working directly with Jeremy Schwartz, CFA®, Director of Research. In January 2014, he was promoted to Associate Director of Research where he was responsible for leading various groups of analysts and strategists within WisdomTree’s broader research team. In February 2018, Christopher was promoted to Head of Research for Europe, where he will be based in WisdomTree’s London office and will be responsible for all of WisdomTree’s research efforts in the European market, as well as supporting the UCIT platform on a global scale. Christopher came to WisdomTree from Lord Abbett, where he worked for four and a half years as a regional consultant. He received his MBA in Quantitative Finance, Accounting and Economics from NYU’s Stern School of Business in 2010, and he received his BS in Economics from Colgate University in 2006. Christopher holds a Chartered Financial Analyst designation.
Editor’s note: The summary bullet points for this article were chosen by the Seeking Alpha editors.