MF3d
Investment Thesis
SentinelOne, Inc. (NYSE:S) is a US-based cybersecurity company founded by Tomer Weingarten in 2013. The company went public in July of last year at a share price of $35, raising approximately $1.23 billion in total revenue. After reaching the all-time high in November, SentinelOne was caught in a broad market sell-off and is now down more than 65%. However, the massive selloff is unjustified in my opinion.
SentinelOne reported its second quarter earnings last week and it again impressed, beating analysts’ expectations on all metrics. The company also operates in a fast-growing industry with a large total addressable market (“TAM”) and benefits from the acceleration of digital transformation. I believe the current share price is compelling and presents a good buying opportunity for long-term investors.
Overview
SentinelOne is a cybersecurity company focused on endpoint protection. The company’s core solution is its Singularity XDR Platform, which uses AI and machine learning technologies to provide automated protection across a variety of surfaces including endpoints, cloud, identity, IoT, email and more yet. The platform is also able to unify all data collected and provide visibility and analytic solutions to businesses. The company also offers a marketplace that provides one-click integration with various partners such as AWS (AMZN), Splunk (SPLK), Zscaler (ZS), Okta (OKTA), and more. Customers are able to leverage these integrations and expand their use cases accordingly. For example, they can sync threats from SentinelOne to ServiceNow (NOW) for unified security operations and incident response. The company has an impressive list of customers including companies like Samsung (OTCPK:SSNLF, OTCPK:SSNNF), Estee Lauder (EL), Electronic Arts (EA), Autodesk (ADSK), and more.
The TAM for endpoint security is huge and presents a tremendous opportunity for SentinelOne. According to Statista, the endpoint security market is forecast to grow from $11.2 billion in 2021 to over $19 billion in 2025. Fortune Business Insights projects the market to grow at a CAGR (compounded annual growth rate) of 8.3% from 2021–2028. The industry is expanding rapidly, as it benefits from numerous tailwinds such as the move to the cloud, and wider adoption of new technologies such as artificial intelligence (AI), internet of things (IoT), and 5g. The increase in cyber threats in recent years has also significantly boosted the demand for endpoint security products.
SentinelOne has been gaining strong traction over the past few years. In August 2019, the company was named a visionary by Gartner, as shown in the first graph below. In a little less than two years, it jumped to the top category, as shown in the second graph. As the company continues to grow, I believe it will continue to gain market shares and may soon catch up with the likes of CrowdStrike (CRWD) and Microsoft (MSFT).
Gartner
Gartner
Acquisition
Earlier this year, SentinelOne acquired Attivo Networks for $616.5 million (nearly 20x price to sales), a leading company in the identity security market. While the price tag is a bit hefty, I really like the acquisition. This enables SentinelOne’s XDR platform to provide a more complete solution by bringing needed identity security capabilities, and also expands the company’s addressable market by over $4 billion as it enters the rapidly growing security space of identity. I believe that the improved platform with expanded capabilities will give SentinelOne a stronger competitive advantage going forward.
Nicholas Warner, COO of SentinelOne, on the acquisition of Attivo
“The shift to hybrid work and increased cloud adoption has established identity as the new perimeter, emphasizing the importance of visibility into user activity. Identity Threat Detection and Response (ITDR) is the missing link in holistic XDR and zero trust strategies. Our acquisition of Attivo is a natural evolution of the platform for protecting organizations from threats at every stage of the attack lifecycle.”
SentinelOne
Financial and Valuation
SentinelOne reported its second quarter earnings last week and they absolutely blew it, beating the consensus on all metrics. The company reported revenue of $102.5 million, up 124% YoY (year over year) from $45.8 million, while ARR (annualized recurring revenue) rose 122% to $438.6 million. International revenue is one of the fastest growing segments, up 135% YoY, now representing 33% of total revenue. Total customer count increased 60% to 8,600 while customers with an ARR greater than $100K grew 117% to 755. The dollar-based net retention rate (DBNRR) was a record 137%, from to 125% last year. This is driven by increased use of new modules and cross-selling of adjacent solutions.
Tomer Weingarten, CEO, on Q2 earnings
We again delivered significant revenue and ARR growth, both growing over 120% year-over-year, driven by strong demand for our XDR platform across endpoint, cloud and identity. We exceeded all of our expectations in the quarter with a strong focus on execution, platform innovation and our partner-friendly go-to-market strategy. Looking forward, we are raising our full-year growth guidance to 103% from the previous 98%. We combine this rapid growth with significant margin improvement, reflecting strong unit economics and operational efficiencies.
ConsensusGurus
The highlight of the quarter was definitely the improvement in gross margins, which has historically been the company’s weakness. Non-GAAP gross margin for the quarter was 72% vs. 62%, up 1,000 basis points YoY. The significant expansion in gross margins was driven by strong economies of scale.
As the company continues to grow its client base and platform portfolio, it is able to leverage the data ingested and reuse it for other various security applications. It also benefits from channel leverage which greatly increases sales efficiency.
SentinelOne
The bottom line remains negative as the company continues to invest heavily back into the business. Operating loss widened from $67.2 million to $108.2 million while operating cash flow became negative $(111.5) million from negative $(72.8) million. Non-GAAP operating expenses increased 80% from $73 million to $132 million, largely attributable to increased R&D and S&M expenses. Operating expenses as a percentage of revenue improved from 160% to 129%. This resulted in Non-GAAP operating margin for the quarter decreasing from (98)% to (57)%, a 42 percentage points improvement. Net loss per share also improved from $(0.57) to $(0.35) this quarter.
SentinelOne
I’m not too worried about the company’s bottom line right now because it’s currently in the hypergrowth stage. I believe profitability will increase as it continues to expand and gain operating leverage. The company’s balance sheet is also very strong. It ended the quarter with about $1.2 billion in cash and equivalents, providing a solid buffer for its current cash burn. The company also raised its guidance for both Q3’23 and FY’23, now expecting revenue of $111 million and $416 million respectively, from $108 million and $406 million.
After the massive decline, I believe the current share price for SentinelOne is very compelling. From the first chart below, you can see that on a FWD EV/sales basis, SentinelOne is currently trading at a discount compared to CrowdStrike and Cloudflare (NET), and on par with Zscaler (I use EV/sales rather than P / S because it takes into account the company’s cash and debt position). However, in the second chart, you can see that it is actually growing revenue almost twice as fast as all of its cybersecurity peers. While SentinelOne has historically had lower margins compared to others, it has significantly improved its gross margin over the past few quarters, as noted above. I believe the valuation gap is unreasonable and the company should trade at a valuation on par with CrowdStrike and Cloudflare as it continues to post triple-digit revenue growth while improving margins.
Conclusion
In conclusion, I believe the current sell-off offers a good buying opportunity for investors. There are certainly concerns about whether the worsening macro environment will affect sales and IT budgets but I believe that cybersecurity is one of if not the most resilient industries today. Most companies are unlikely to reduce their security spending as the number of cyber threats continues to rise. The industry is also benefiting from many tailwinds such as digital transformation and the move to the cloud.
Despite the difficult conditions, SentinelOne still managed to grow revenue by more than 120% and continue to improve its margins, demonstrating the strength and stability of the company. It also trades at a discounted valuation compared to its peers when considering its growth rate. Therefore, I rate SentinelOne as a buy at the current price.