2023-08-22 09:13:35 ET
Summary
- Increased competition has led to doubt regarding SentinelOne's viability as a standalone company in recent quarters.
- SentinelOne is rumored to be considering a sale, although little detail is available at the moment.
- While this has provided a boost to the stock price, it likely implies the business is struggling.
- Despite the stock appearing attractively priced relative to peers, there could be substantial downside if second quarter results are poor.
SentinelOne's (S) stock has moved modestly higher on the back of takeover rumors. While there is currently little information available, this is not particularly surprising, due to both the company's valuation and technology. A firm offer could still drive the stock significantly higher, but the fact that SentinelOne is seriously entertaining offers with its share price still depressed probably also indicates the company's recent struggles are ongoing. As a result, if an offer does not eventuate, there could be substantial downside.
Acquisition Rumor
SentinelOne is rumored to be considering a sale, having hired Qatalyst Partners to advise it on discussions with potential acquirers. SentinelOne is likely to draw interest from both private equity firms and strategic acquirers due to the company's valuation, strong balance sheet and technology portfolio.
Given where SentinelOne's stock currently sits, and where it has traded for much of the past two years, it seems likely that SentinelOne would want a significant premium from its current share price. Initial expressions of interest reportedly did not meet SentinelOne's valuation expectations though.
Market
This news comes in the face of an uncertain cybersecurity demand environment. Investors were spooked when Fortinet (FTNT) reported soft results, but this now appears to be something of an idiosyncratic issue, with hardware demand generally looking soft and software demand more resilient. Commentary from Palo Alto Networks (PANW), Check Point Software (CHKP) and Cloudflare (NET) seems to indicate that while the market is still difficult, conditions appear to have stabilized somewhat.
The health of endpoint security demand likely won't be known until after CrowdStrike (CRWD) and SentinelOne report their Q2 FY2024 results in the next few weeks. Palo Alto's Cortex business appears to be performing well, though, driven by the launch of its XSIAM service. Much of this strength appears to be coming from large customers, which may be less relevant for SentinelOne.
Job openings mentioning endpoint security in the job requirements certainly do not point towards a rebound in demand. A generally lethargic white collar job market is also likely still a headwind for seat-based pricing businesses.
Figure 1: Job Openings Mentioning Endpoint Security in the Job Requirements (source: Revealera.com)
SentinelOne's job openings are still depressed, which could indicate that growth is an ongoing problem or that the company is now prioritizing profitability over growth. The number of job openings has rebounded somewhat from the June lows, which could be interpreted as a positive sign.
Figure 2: SentinelOne Job Openings (source: Revealera.com)
Viability as a Standalone Company
There have been mounting questions regarding SentinelOne's viability as a standalone company in recent quarters, with CrowdStrike, Palo Alto and Microsoft (MSFT) all formidable competitors.
Cybersecurity is a rapidly evolving market which requires large investments in R&D or acquisitions for leaders to remain at the forefront. Access to data is also becoming increasingly important, making scale an important competitive advantage. In addition, many customers are looking to consolidate vendors to reduce cost and complexity, while also potentially driving better outcomes. Large companies that can offer a broad portfolio, like Palo Alto, are well positioned to compete in this environment, even if they don't necessarily have the best point solutions in every area. These factors raise questions about SentinelOne's ability to succeed long-term as a standalone company.
Rapid growth deceleration in recent quarters has provided fuel for the narrative that SentinelOne is struggling. While much of this is likely attributable to market conditions, CrowdStrike has increased its focus on the SMB segment, which has probably increased competition. This segment is SentinelOne's historic core, and is probably also under threat from Microsoft's Defender, which is good enough for many organizations even if it is not the best solution from a technical perspective. SentinelOne's expanded product portfolio (Singularity Cloud, Attivo, DataSet) also doesn't appear to be gaining traction to the same extent as CrowdStrike's.
Figure 3: SentinelOne Revenue Growth (source: Created by author using data from company reports)
SentinelOne has also struggled with large losses, which have likely deterred many potential investors. SentinelOne's gross profit margins are relatively low and its operating expenses high. Elevated operating expenses are a function of SentinelOne's modest scale and high growth rate. Tough market conditions are also impacting the efficacy of sales and marketing investments. Most concerning is probably SentinelOne's general and administrative expenses, which are high and have shown little sign of decline over the past two years.
Despite this, SentinelOne has high gross retention rates and a reasonably broad portfolio, which provides upsell and cross-sell opportunities. This should lead to decent profit margins in time, dependent on competitive positioning.
Figure 4: SentinelOne Operating Expenses (source: Created by author using data from SentinelOne)
Valuation
There have been a number of acquisitions by private equity firms in the cybersecurity space over the past few years, including McAfee Corp, Ping Identity, ForgeRock, Sailpoint Technologies and Magnet Forensics.
Many of these offers were at a mid-to-high single digit revenue multiple and at a 15-50% premium to the share price prior to the acquisition offer. If SentinelOne could attract a similar offer it would not be unreasonable to expect 18.50-20.00 USD per share. Cybersecurity probably isn't viewed as the hot area like it was in 2021 and 2022 though, which may mean any potential offers are lower, despite the recent move higher in the general market.
Given where SentinelOne's stock has traded for much of the past two years, it is not clear that this type of offer would appeal to investors though, unless the company's problems are increasing. If an offer is not forthcoming, SentinelOne's stock could still fall much further, despite its relatively modest valuation, as there are no profits or free cash flow to support the stock. This will depend on whether growth begins to show signs of stabilization and to what extent SentinelOne can drive improvements in GAAP profitability.
Figure 5: SentinelOne Relative Valuation (source: Created by author using data from Seeking Alpha)
For further details see:
SentinelOne: Takeover Rumors May Mean The Bull Case Is Dead