2023-04-20 10:35:59 ET
Summary
- SentinelOne, Inc. is moving towards non-GAAP breakeven profitability at a breakneck pace. By fiscal 2025 (next year), SentinelOne expects to reach breakeven non-GAAP operating margins.
- This would be a massive swing in profitability in just 2 years.
- And yet, I believe that SentinelOne, Inc. stock is still too expensive.
Investment Thesis
SentinelOne, Inc. ( S ) is a stock that I've been openly bearish on for a long time.
And while I admit that SentinelOne is clearly making strong progress in improving its profitability profile, I assert that investors' expectations are still too high.
Why SentinelOne? Why Now?
SentinelOne is an endpoint protection cybersecurity company. The business is unquestionably one of the top leaders in cybersecurity. And yet, perhaps because I'm biased since I'm long Palo Alto Networks, Inc. ( PANW ), but I struggle to see the long-term appeal of this business.
To be clear, I'm not only discussing its lack of profitability - although, obviously, that's also a massive consideration. But I merely struggle to reconcile investors' expectations and how this leaves potential new investors with any upside potential.
The investment case here appears to be that, relative to CrowdStrike Holdings, Inc. ( CRWD ), SentinelOne is cheaper. But this, I argue, is not sufficient to buy this stock.
In fact, I contend that this time last year, the macro environment was significantly more amicable and conducive toward an overabundance of cybersecurity companies.
After all, this time last year, Russia's invasion brought about a significant amount of awareness of the need for next-gen cybersecurity platforms. More specifically, this time last year there was no shortage of demand for cybersecurity platforms. This led to SentinelOne's customers spending more than $100K annualized to jump into the triple digits y/y.
S Q4 2022
But that was then. And now?
Today, there's a need for vendor consolidation. What that means in practice, is that every enterprise is more price sensitive. The obvious companies to push back on their IT budgets are small and medium-sized companies. But even amongst large enterprises, the message is clear, the IT sector is questioning every expense line.
S Q4 2023
Undoubtedly, Very Strong Revenue Growth Rates
Realistically, I don't believe that anyone is arguing that SentinelOne's growth rates are not impressive. These growth rates are terrific.
The problem, though, is that it's one thing to rapidly grow your business when you don't need to be concerned about the underlying profitability of the business. But it's quite another to pivot the company's culture from ''growth at any cost,'' to thinking about the long-term viability of the business.
Again, I very much admit that there's a significant need to prevent, detect, and respond to cyberattacks in real time at machine speed. Along these lines, this is what SentinelOne's founder and CEO Tomer Weingarten stated on the earnings call :
The cloud security market has the potential to become even larger than the endpoint market over time. As enterprises are rapidly shifting workers to the cloud, rising cloud-based attacks are bringing awareness to this critical enterprise need.
Recall, endpoint security protects browsers, any device type, or servers. However, future growth demand will definitely come from the cloud, as echoed in Weingarten's quote above.
Coveted Path to Profitability
We expect to deliver another year of significant operating margin improvement and continue our progress towards achieving profitability in fiscal year '25. (Tomer Weingarten, Co-founder and CEO of SentinelOne, Q4 earnings call ).
SentinelOne has made tremendous progress in improving its profitability profile in the past year and half.
And looking ahead, SentinelOne charges that by next year, it will take its guided non-GAAP operating margin from negative 25% to breakeven.
And that's troublesome. If, indeed, SentinelOne could improve its profitability profile from negative 95% to breakeven in two short years, that would lead to a dramatic slowdown in its pace of investment.
Put another way, for fiscal 2023, for every dollar of revenue, SentinelOne was investing nearly $1 of operating losses back into the business, excluding stock-based compensation.
If by fiscal 2025, it would somehow reach breakeven profitability, this will leave SentinelOne without much in the way of investment, which would have a knock-on impact on its pace of growth.
The Bottom Line
I understand what SentinelOne, Inc. is attempting to achieve. I also understand its opportunity and potential. Furthermore, I also recognize that its multiple has already been cut down. But even with all that considered, I still declare that paying nearly 8x for this business is too expensive.
Because I believe that SentinelOne, Inc. effort to improve its profitability should lead to a significant slowdown in its growth rates, which will take investors by surprise.
In conclusion, SentinelOne, Inc. investors have too high expectations priced into the long-term prospects of this business.
For further details see:
SentinelOne: Rapidly Moving Towards Profitability, And Yet...