2023-09-25 03:31:25 ET
Summary
- SentinelOne has experienced a slowdown in growth due to the current macro environment, but the stock market reaction may have been too fierce.
- Q2 results showed reasonable growth in annual recurring revenue and improved profitability metrics.
- S stock has raised its guidance for Q3 and full-year revenue, and the company's valuation is reasonable and quite low risk.
Investment Thesis
SentinelOne ( S ) is a relatively new start-up in the cybersecurity space, differentiating itself with state-of-the-art technology against the likes of CrowdStrike ( CRWD ) and Microsoft ( MSFT ). While the growth rate has seen quite a slowdown due to the current macro environment, arguably the stock market reaction has been too fierce, as the long-term potential for strong continued growth remains.
Background
My last coverage of the stock was while it was still growing at triple digits. While the growth rate has slowed down, the stock price has come down just as well, providing an opportunity for both existing and prospective investors: SentinelOne Stock: Doubling Down On This Rocket Ship.
Q2 results
SentinelOne has experienced a slowdown in growth in the wake of the macro turbulence this year. Nevertheless, ARR (annual recurring revenue) still came in reasonably at $612M by adding $49M during the quarter, marking a 47% YoY growth rate for ARR. Gross margin reached a record 77%, within the long-term target.
This gross margin unit cost performance is also visible in the profitability metrics, which SentinelOne has focused on more strongly lately as the growth rate has slowed down (at least compared to the hypergrowth of the past). Operating margin improved by 34 points YoY to -22%, its 8th consecutive quarter of an over 25-point improvement.
While some folks may (have) cast doubt on the company's profitability, SentinelOne has simply been investing heavily in the business in areas such as sales and marketing, as well as R&D. Given the market size of the cybersecurity space, this was a sensible strategy when money was cheap, but SentinelOne has successfully pivoted away from a growth-at-all-costs strategy.
The improvement in FCF was 55 points from -$67M to -$15M. SentinelOne has expressed confidence in achieving positive FCF in the second half of next year. SentinelOne has further experienced the strongest growth in its highest ARR cohorts of $100k and $1M. Net retention was "more than 115%", citing budgetary constraints among customers for the relatively low print, which it believes is a temporary headwind. SentinelOne highlighted its platform approach for expanded module adoption (with increased product portfolio), as well as its partners.
Also, given the hype regarding AI this year, SentinelOne also mentioned and highlighted its AI capabilities. One example includes:
Enterprises need a specialized security approach centered on all enterprise data to prevent attacks. Our autonomous technology brings this vision to life with a unified AI-based security analytics platform that seamlessly aggregates and connects data from all security products to deliver enterprise-wide visibility in a single streamlined technology and interface.
Guidance
After previously lowering its guidance, SentinelOne has raised its guidance. Revenue for Q3 is expected to be $156M, 35% growth YoY, and net new ARR is expected to be roughly flat QoQ. Admittedly, this marks another quite firm slowdown, and the thesis for this stock should be a return to or at least stabilization of the growth rate.
While this may be somewhat of a bet, it should not be unreasonable to expect an improvement in financial performance as the macro environment improves. The overall market opportunity remains vast (SentinelOne quotes $100B) and its technology remains leading edge as well.
Full-year revenue is now expected to come in at $605 million, a 43% increase, and ARR is expected to increase in the high 30s, which is an increase of several points compared to previous mid-30s guidance.
During the earnings call , the company also launched a quite unambiguous attack on CrowdStrike, apparently in response to its comments:
I think if you want to talk about competitors, let's also talk about the blatant misrepresentations they had on their earnings call made so clearly. I think it's unbelievable that you see them calling out or implying that, you know we are a coin for a company when it's plain to see that we're the broadest platform out there. When they call themselves a unified platform but actually have two distinctively different platforms, two consoles, two languages, two product lines, that's an overt missed representation and that confuses customers, I think it's just shocking to see that.
Valuation
The company trades for (less than) 8x P/S for the current year and (less than) 6x next year's expected revenue. For a company growing at its current rate and given the massive long-term potential to grow revenue into the billions - perhaps larger than its current market cap - the valuation is certainly quite reasonable and arguably low risk.
I have previously likened the company to CrowdStrike, and despite some of the near-term turbulence, I see no reason why the overall trajectory couldn't be quite similar since cybersecurity remains as relevant as ever.
Risks
SentinelOne has indicated it does not intend to sacrifice (too much) growth on its path toward profitability. It remains a growth stock. However, with the growth rate potentially falling into the 30s (unless the company beats), investors should look for a stabilization in that regard. Similarly, the net new ARR growth has also remained quite flat around $50M.
Investor Takeaway
Clearly, the growth rate has declined by more than investors would have liked, but the company remains a compelling investment in the cybersecurity space due to its leading technology. And despite the lowered growth expectations in the near term, the company has continued to execute quite flawlessly on its path to profitability due to disciplined spending and leverage from strong unit economics.
Combined with a very reasonable valuation (which in the worst-core SentinelOne could grow into, or in the best-case the valuation could even expand if the growth would reaccelerate and/or interest rates would be lowered), I remain bullish on the stock.
For further details see:
SentinelOne: Small But Nimble Fish Against CrowdStrike, Microsoft