S - SentinelOne: Land And Expand Federal Agency Wins Legitimate Generative AI Opportunities

2023-12-06 11:00:45 ET

Summary

• S1 has raised guidance with a great quarter demonstrating an increasingly established tier 1 profile, better profitability and more products upcoming.
• With generative AI and network effects from reaching scale in processed data, with its data products being the best performers, their appeal only grows on the market.
• Initiatives from last year are also demonstrated to have worked, and despite pricing initiatives, a broader offering has been absorbed by markets implying substantial share gains.
• The cash profile is good, and the valuation is not unappealing relative to some competitors.
• We think S1 has a good chance of keeping up the momentum, but will continue with our own lower-multiple bias.

SentinelOne ( S ) is looking great. New product lines, success in selling new modules, and new lead generation opportunities are on the horizon, with the current quarter already demonstrating S1's ability to win contracts with high-sigma customers like government agencies. The figures are great, and the markets are loving the improvements to guidance. Really, everything is looking up despite the fact that there were pressures on budgets in general, and we were seeing elongated cycles last year and generally tighter purses. Finally, the loop looks closed on dilutions, reflexivity risk has become pretty minimal especially as the price rises virtuously. We do call out around 15% dilution from shares outstanding on compensation plans and other options.

Earnings

Let's start with the key data that is driving today's price action.

Revenue grew 42% to $164 million and ARR grew 43% to $664 million, reflecting a net new ARR of $52 million in the quarter. Our net new ARR exceeded our typical third quarter seasonality and accelerated to 11% year-over-year growth. Our growth has accelerated despite persistent macro challenges.

...Our ARR per customer rose 15% year-over-year to approximately $60,000 per customer. In addition, our momentum with MSSP partners, and by extension SMBs, was particularly strong as it continues to fuel a solid base of long-term growth.

...In Q4, we expect revenue of about $169 million, reflecting growth of 34% year-over-year. For the full year, we expect revenue of about $616 million, reflecting growth of 46% in fiscal year ‘24. This is an $11 million increase compared to the prior outlook of $605 million, above and beyond our Q3 beat. Based on this view, we’re on track to deliver about $200 million in net new ARR for the year, up from our prior expectation of $195 million.

...on a constant currency basis we’re assuming, we’d have been roughly at about 77.5%, which is what we’re guiding for Q4.

Dave Bernhardt, CFO of S1

In all, we see r esults from the actions taken last year to increase the number of modules offered to MSSPs , which is driving growth in this channel. The Data Lake product is one of the best performing, and the economics are on a digestion rather than per-seat basis, which diversifies cash flow dynamics of the company. The openness to other endpoint vendors has been a selling point, but in general the land-and-expand strategy has been working really well, with high profile customers, driving up the ASPs, taking on their full suite of services in some major contract wins ousting competitors whose more legacy technology, particularly in security information and event management solutions, or SIEM, and also from consistent share donors like Carbon Black which lack S1's universality and comprehensiveness.

There was very little the analysts on the call had to say that could be negative. There was a mention of stagnating billings, but this is industry wide and is simply a cash flow effect where overall demand, particularly for S1's products, continues to grow, but billings are slower because there isn't really leverage anymore to request a lot of upfront payments. This is consistent with the elongated sales cycles and generally higher consideration for budgets among corporates.

Another analyst thought that customer counts, now at around 11,500, came below expectations. These figures do not include the many customers served by MSSPs in the mid-market, and this was one of the more fiercely growing channels. What's more is that there really isn't any doubt of the fact that S1 is a tier 1 provider at this point, winning contracts with Federal Agencies that usually take a high-sigma approach to onboarding new providers, and are among the toughest nuts to crack. Bidding into these markets successfully actually helps build a premium argument around S1, where cybersecurity providers in general, and not just in software, typically trade at premium multiples once they've established themselves with government customers.

Another thing to note is the margins. 77.5% on the gross margin is great, and actually ahead of the more mature competitors. Naturally, the company is still burning cash , but improving cash flow situation and an easy 2 year runway on current balances with profitability in reasonable sight, reflexivity is no longer a discussion point. Dilution risks can be ignored at least as far as the cash burn goes, although we do call out quite a lot of outstanding shares reserved for various compensation programmes that will cost shareholders 15% in dilution in the medium term, and around 30% longer term with all the reserved shares. This, we can assume, will be paid out given the strong operating momentum and general price action.

Bottom Line

We calculate the forward EV/Sales at around 9.3x including full dilution effects and current cash. That's still lower than Palo Alto Networks ( PANW ) as an immediate comp which is at around 10.8x.

While S1 isn't profitable yet, a discount isn't that sensible, especially since we think the company has more rounds in the mag for the coming year. Purple AI needs to be mentioned, and generative AI that leverages the vast amount of data the company processes, and also the open source nature of a lot of what goes on in OS's in data centers. This is not making money yet, and is more distinct from the current modules and probably makes its own product. The market could be very substantial, and the application is pretty useful it seems .

There's also PinnacleOne, which is a strategic cybersecurity advisory branch that they've begun now with some experts from top tech companies as well as former government employees. This could be a substantial lead generator for the company, and with more breaches and generally more accountability of boards and executives for breaches (it's seen as a systematic, infrastructural issue now with how frequent breaches have become), it should be pretty successful in generating leads. It's unclear how big this business might get, but considering the meaningful sizes of the cybersecurity consulting businesses out there, it's conceivable that it won't be a small branch, and while it may drag on gross margins a bit since it's people intensive, a dollar in consulting could be cross sold into several dollars of SentinelOne's various products and modules.

Overall, there is a relative valuation case, demonstrated execution, growing reputation and various early-innings initiatives that make us somewhat optimistic about the future of S1, although we have a bias towards lower multiple sectors of the market since we are quite unsure of what is coming economically, despite secular forces undergirding cybersecurity.

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