Summary
- SentinelOne could be well positioned to capture an attractive share of the fast-growing and large market for cybersecurity solutions.
- McKinsey suggested that the potential global market size for cybersecurity could be between $1.5 and $2 trillion.
- During the period from October 2021 to October 2022, SentinelOne's topline expanded to $362 million, a year-over-year growth of approximately 114%.
- SentinelOne is still loss making. But the company's management is confident that the firm can write a profit as early as 2025.
- Personally, I value SentinelOne stock based on a residual earnings model and calculate a fair value for S stock of $21.01/share.
Thesis
I have previously argued that, as a consequence of a rich valuation, investing in SentinelOne (S) is too speculative. But after the stock has depreciated close to 27% in value, and at some point even touched my target price of $13.73, I believe it is time to revisit the thesis for investing in SentinelOne.
In fact, on the backdrop of a favorable long-term market tailwind, paired with strong management execution in times of macro challenges - as evident by SentinelOne's TTM performance, I upgrade S stock to a speculative 'Buy'; and I now calculate a fair implied target price of $21.01/share.
For reference, SentinelOne stock is down approximately 62% for the past twelve months, as compared to a loss of about 7% for the S&P 500 ( SPY ).
Strong Performance Despite Macro Challenges
One key argument that made me reflect on the SentinelOne thesis is anchored on the firm's exceptionally strong performance for the trailing twelve months , despite macroeconomic headwinds. During the period from October 2021 to October 2022, SentinelOne's topline expanded from $169 million to $362 million, a year over year growth of approximately 114%. Similarly, gross profit jumped from $98 million to $233 million, a 138% growth respectively. Moreover, as of October 31, 2022, SentinelOne's total number of customers stood at over 9,250, reflecting an increase of approximately 55%. The dollar-based net revenue retention rate for the period was 134%.
Admittedly, SentinelOne is still loss making--and this has not improved much since a year ago. For the trailing twelve months, SentinelOne has accumulated an operating loss equal to $369 million, as compared to a loss of $233 million for the same reference one year earlier. Investors should consider, however, that an expansion of operating expenses such as R&D and sales/ marketing might not necessarily be bad. In fact, for growth companies these expense buckets can to some extend be classified as 'investments'.
In any case, on the backdrop of a strong 2022 performance, SentinelOne management confirmed targets for 2024 and 2025, indicating breakeven profitability by 2025.
Our long-term margin targets remain intact and our goal is to reach operating breakeven for fiscal year 2025 , which is primarily calendar year 2024. We are making excellent progress.
... When thinking about our path to profitability from here, consider our Q4 margin guidance. We are on track to exit fiscal year 2023 with two quarters of about 25 percentage points at the year-over-year operating margin improvement.
Continuing this progress forward, we expect another 25 points of operating margin improvement in fiscal year 2024 and our goal is to achieve profitability in fiscal year 2025. We are laser-focused on execution to stay ahead of evolving economic conditions. Our strategy is to dynamically invest in our technology and business, while enhancing our path to profitability.
As an additional note on SentinelOne's financials, investors should also consider that SentinelOne has a strong balance sheet, with net cash of $674 million.
The Cybersecurity Market
Given the rising occurrences of cyber threats, data breaches, and various forms of cybercrime, the market for cybersecurity is estimated to grow at a 13.4% CAGR for the next 7 years, reaching $376.32 billion by 2029. This growth is supported by the adoption of novel technologies such as cloud computing, the Internet of Things, and 5G networks, which create fresh vulnerabilities requiring protection. Another key demand driver for the market is the increasing complexity of the threat landscape, with attackers using a wider range of tactics, techniques, and procedures (TTPs) to breach organizations' defenses. With that frame of reference, the SentinelOne's XDR (extended detection and response) application system--powered by artificial intelligence--is well positioned to capture client interest.
With that frame of reference, in the Q3 post-earning conference call with analyst, SentinelOne's CEO Tomer Weingarten voiced bullish sentiment with regards to the company's growth and competitive potential:
While growth is slowing because of macro conditions in the near-term, we remain confident in our ability to deliver high levels of growth next year and beyond. We expect to continue to win market share and outgrow the competition.
Based on a prudent view of the current economic environment and expectations of further macro deceleration, we believe we will deliver at least 50% total ARR growth in fiscal year 2024. This is also based on our growing pipeline, strong win rates, high retention and expansion rates, and the enterprise need for security.
For reference, McKinsey estimated that cyberattacks could result in damages worth up to $10 trillion per year. And, anchored on a survey of 4000 mid-sized companies, McKinsey suggested that the potential global market size for cybersecurity could be between $1.5 to $2 trillion, which is about 10 times larger than what is currently addressed.
Valuation Update: Raise Target To $21.01
I now estimate that SentinelOne's EPS in 2023 will likely fall to somewhere between $-0.4 and $-0.2. In addition, I slightly raise my EPS expectations through 2025, expecting a slightly more favorable profitability outlook. I now model that SentinelOne will likely achieve EPS of $1.3 in 2027.
Reflecting on a positive tailwind for the global cybersecurity market through 2030, which is not fully captured in my EPS estimates until 2027, I continue to see a 3.5% terminal growth as justified (about one percentage point higher than estimated nominal global GDP growth). I continue to anchor on an 8.5% cost of capital.
Given the model updates as highlighted below, I now calculate a fair implied share price of $21.01, as compared to $13.73 prior .
(Topline numbers highlight my post-Q2 2022 assumptions)
Below is also the updated sensitivity table.
Risks
As I see it, there has been no major risk-updated since I have last covered SentinelOne stock. Thus, I would like to highlight what I have written before :
Investors looking to buy into SentinelOne's equity - despite the stock's valuation premium - should be aware of the following downside risks: First, SentinelOne is writing losses. There is no guarantee that the company will achieve significant profitability in the next few years, if ever. Second, a worsening macro-environment including inflation and supply-chain challenges could negatively impact SentinelOne's customer base. If challenges turn out to be more severe and/or last longer than expected, the company's financial outlook should be adjusted accordingly. Third, investors should monitor competitive forces in the cybersecurity industry. If competition increases more than what is modelled by analysts, profitability margins and EPS estimates for SentinelOne must be adjusted accordingly. Fourth, much of SentinelOne's share price volatility is currently driven by investor sentiment towards risk and growth assets. Thus, investors should expect price volatility even though SentinelOne's business outlook remains unchanged. Finally, inflation and rising-real yields could add significant headwinds to SentinelOne's stock price, as the higher discount rates affect the net-present value of long-dated cash-flows.
Conclusion
SentinelOne could be well positioned to capture an attractive share of the fast-growing and large market for cybersecurity solutions, which could unlock a market potential of up to $2 trillion - as estimated by McKinsey. Admittedly, the Israel-based cybersecurity company is still loss making. But the CEO Weingarten is confident that the firm can write a profit as early as 2025.
Personally, I value SentinelOne stock based on a residual earnings model and calculate a fair value for S stock of $21.01/share.
For further details see:
SentinelOne: The Risk/Reward Has Now Become Favorable