SentinelOne stock: hyper-growth and undervaluation (NYSE: S)
SentinelOne (New York Stock Exchange: S) is a leading cybersecurity company serving one-third of Fortune 10 companies and hundreds of Fortune 2000 companies. The company posted “hyper-growth” and “outperformance” in the second quarter, beating revenue and profit estimates. Despite this, the stock is still down more than 66% from all-time highs and undervalued to all-time multiples. In this article, I’m going to break down the business model, financials, and valuation of the company, let’s dive into it.
Secure business model
SentinelOne is a leader in endpoint security. For those unfamiliar, “endpoints” refer to the “end” user devices we use to connect to a network, this can be a desktop computer, laptop, mobile phone, tablet , etc.
As these devices are at the “end” of the network and are often used remotely, they are increasingly vulnerable to cyberattacks. The Rise of Hybrid Working and the Internet of Things [IoT] devices also increase the need for strong endpoint security. Therefore, it is not surprising that endpoint security industry is expected to grow at a steady CAGR of 8.3%, from $13.99 billion in 2021 to $24.58 billion by 2028.
According to Gartner, SentinelOne is a “Leader” in this market. Peerspot tech review website also ranks SentinelOne as “Leader” with third place for Endpoint Protection Platforms. Its software is second only to number one leader CrowdStrike (CRWD) and Microsoft Defender for Endpoint.
Although CrowdStrike is ranked higher, SentinelOne has Published a useful comparison between the two platforms. This comparison cites a third-party benchmark called MITER Engenuity ATT&CK Evaluation. SentinelOne provides 100% protection and 99% real-time visibility during the attack. While the competitor CrowdStrike detected only 94 out of 109 detections, 11 of which were delayed. Now, while this test should be taken with a “pinch of salt” as quoted by a competitor, it uses a third party and is a strong selling point for customers. Today’s B2B marketers love to self-educate, and one of the burning questions they’ll likely want answered is how the platform stacks up against its competitors.
The SentinelOne platform is called “Singularity XDR” which stands for Extended Detection and Response. The platform provides the IT security team with a “single window” to view, protect and remediate cybersecurity threats.
To do this, it uses behavior-based artificial intelligence [AI] to monitor, track and contextualize all event data. The company turns “data into stories” and then “stories into context”. It detects the normal security posture of a user’s device and then looks for anomalies in that posture.
Recovery of many terminals [EDR] platforms use the 1-10-60 rule. This basically means that it typically takes one minute to detect an attack, 10 minutes to investigate, and 60 minutes to respond. While SentinelOne investigates and responds automatically without human intervention, which is a key selling point.
The company recently extended its platform to cover identity security through its acquisition of Attivo Networks, which she completed in May. This new platform will extend TAM for SentinelOne by helping customers implement a “Zero Trust” security strategy. This basically states that users should only have access to the apps they need, this is called “least privileged access” and prevents “lateral movement” by attackers.
Its acquisition also allows the company to further activate its “land and expand” sales strategy, which involves upselling and cross-selling modules.
SentinelOne generated huge financial revenue results for the second quarter of fiscal 2023. Revenue rose 124% year-over-year to $102.5 million, beating analyst estimates of $6.84 million.
Annualized recurring revenue [ARR] also jumped 122% to $438.6 million, which is a positive sign.
SentinelOne has over 8,600 customers, up 60% year over year. His clients include 3 of the Fortune 10s and hundreds of Fortune 2000s. Examples include big name brands such as Aston Martin, Hitachi, EA, TGI Fridays, AutoDesk, and even the State of Montana. Additionally, its largest customers with an ARR greater than $100,000 grew 117% year-over-year to 755. Upscaling to serve larger customers is a solid strategy, as these tend to offer greater income security and greater upsell opportunities.
SentinelOne also achieved an all-time high dollar net revenue retention rate of 137%. This means customers find the product “sticky” and spend more. As a SaaS company, SentinelOne achieved a high gross margin of 65%, compared to 59% the previous year. However, it should be noted that the company is operating at a loss with a GAAP operating margin of -106%, compared to -147% previously. On a non-GAAP basis, its operating margin was -57%, which also improved from -98% a year earlier. Earnings per share were -$0.35, which beat analysts’ expectations of $0.05.
For a traditional value investor, any loss may seem like a bad sign, but when we dive under the hood, we see the reasons behind it. Total operating expenses were $174 million, up 85% year-over-year. This may seem negative at first glance, but it’s clear that this growth has been driven primarily by an increase in headcount as the business scales. Additionally, we are seeing high operating leverage across all expenses, which is positive. Improving operating leverage essentially means that its fixed costs decrease as a percentage of revenue. It’s common for software vendors to have high operating leverage because they have high upfront costs to build the platform, but can then scale easily without as much Capex. In this case, we see improvements at all levels, general and administrative costs have gone from 48% to 39% over the year. Sales and marketing spend also showed improved efficiency from 90% of revenue to 77% of revenue. Furthermore, R&D expenditure fell from 68% to 54% of sales. So, although his expenses increased on a relative basis, his income grew at a faster rate.
SentinelOne has a strong balance sheet with $1.2 billion in cash, cash equivalents and short-term investments. On top of just $29.3 million in debt, which is a positive sign given rising interest rates.
According to SentinelOne CFO Dave Bernhardt,
“We are raising our full-year growth expectations beyond our outperformance in the second quarter.”
This confidence is a really positive sign, especially given the macroeconomic environment. Management expects $111 million for the third quarter, which will reflect 98% year-over-year growth. Plus $415-417 million in FY2023, representing a 103-104% year-over-year growth rate.
In order to value SentinelOne, I incorporated the latest financial data into my advanced valuation model, which uses the discounted cash flow valuation method. I projected 100% revenue growth for the next year, then 53% revenue growth for the next 2-5 years.
I also forecast that the company’s operating margin will increase to 23% (which is the software industry average) over the next 8 years. I expect this to be driven by increasing operating leverage in line with the current trend, acquisition synergies, modular cross-selling and maintaining high retention rates.
Taking these factors into account, I get a fair value of $34 per share, the stock is trading around $25 at the time of writing and is therefore over 27% undervalued.
As an additional data point, SentinelOne trades at Futures Price-to-Sales Ratio=17, which is slightly cheaper than its competitor CrowdStrike (CRWD) which trades at Price-to-Sales Ratio=18. form of identity Okta is the cheapest cybersecurity stock in my comparison after a substantial drop of 30% in a single day. But it should be noted that the income of this company should decrease, and not increase rapidly. I recently wrote an in-depth article on Okta if you want to learn more about the cheapest cybersecurity stock in the industry.
As mentioned earlier, SentinelOne faces competition from CrowdStrike, Microsoft Endpoint Security and more. The platform is a “leader”, but it does not hold the top spot according to most industry reports such as Gartner. However, the market for endpoint security is huge, so I don’t see this as a major issue.
Many analysts are forecast a recession in the coming quarters, and so many companies may decide to temporarily delay spending on new software. However, I think the threat to cybersecurity is so abundant and newsworthy that the secular trend is on the rise.
SentinelOne is a technology powerhouse that offers highly rated software for cybersecurity. The company produced excellent financial results in the second quarter and does not appear to show any signs of slowing down. If the company can achieve the growth rate targets I have described, the stock is undervalued. However, I expect short-term volatility due to macro issues.