SentinelOne Stock: Looks Cheap For A Cybersecurity Firm (NYSE:S)

SentinelOne (NYSE:S) could be called a fallen angel. Last year its market cap was 3x where it is now. The latest earnings report confirms that despite a tougher environment, and the difficult comps from an ebullient 2021, SentinelOne is continuing to deliver growth, and there are plenty of levers they have yet to pull. Many of their offerings aren't being sold through the managed security service providers (MSSPs) that they work through, and those will start being sold together with the other cybersecurity modules as part of their Singularity platform. They are substantially an AI play too, and while the current market doesn't get giddy from hearing the AI buzzword, the future still favors these AI players, and there are a lot of ways that AI is a bigger megatrend within cybersecurity than tech in general. The multiple is pretty low and the company is very well capitalized. We see a lot of potential in SentinelOne.

SentinelOne Q3 Earnings Breakdown

The gross profits have more than doubled on a 3-month and 9-month basis YoY. Sequentially, there's been decent improvement in the topline as well despite increasing macro pressures. Around 10-15% sequential growth is decent, and management is guiding towards more than 20% sequential growth in Q4, with YoY growth expected to be 50% on the low end. Some deals worth a couple of million slid into Q4, and these figures aren't being accounted for.

Several growth drivers are accounting for improved sequential figures. The first is that they sell through managed security providers, who package their AI powered threat detection platform, Singularity, together with other professional services in IT and cybersecurity. They previously allowed only some modules to be sold through these channels, but they have just started allowing more of the modules to be sold.

For the first time, we have actually enabled them to sell new modules that happened last quarter for the first time. So it’s just the first innings of that opportunity.

Tomer Weingarten, CEO of SentinelOne

The other is that there is generally a strong offering going on, and that they are winning larger and larger clients, where higher tickets are customers sizes are driving growth. While greater budgetary scrutiny is being observed around larger customers, they are still moving forward with essential cybersecurity.

Another really interesting comment from the company has been about the competition. SentinelOne pulls no punches when it comes to discussing their offering relative to competitors. On their website, they call McAfee a 'Pale Performer', and call out competitors extensively by name for having a less unified service and more hidden costs. In this quarter, they mentioned that they are seeing a good deal of business from customers bailing on Microsoft (MSFT) Defender, which is one of the services that directly competes with Singularity.

The second dynamic I want to highlight is that we have seen more and more Microsoft displacements, customers rebounding from Microsoft offering. Some citing it as eventually an eventual cost terms, the most expensive solution they had to manage over the years.

Tomer Weingarten, CEO of SentinelOne

This is obviously a great sign. They call out Palo Alto Networks (PANW) too with their competing offering. I've not seen a company name and shame like SentinelOne does before.

Bottom Line

The company mentioned difficulties with larger customers. They are a little more constrained in their land and expand strategy, particularly in the expansion part where large corporates are looking to keep costs low. But they are still ordering and that's what matters. While it's difficult for SentinelOne to evaluate what is going on in the SMB segment because they usually get to them through selling to MSSPs, the MSSP channel is still going strong and there's no sign of particular problems. In general, it's just longer deal cycles.

From a valuation point of view, SentinelOne trades at 3.8x P/S, and sales understate their run-rate revenues because of their sharp billing growth trajectory and subscription-based model. The P/ARR multiple is 2.4x. While they are currently burning more than $200 million annually on a run-rate basis, they have $1.2 billion in cash and securities with no debt. They'll not need to dilute. Surely by the time they run down their cash balances they'll have plenty of capacity to raise debt, since they'll be approaching profitability.

The economics of the business are good. They benefit from network effects in their data lake and strong subscription economics. In fact, cybersecurity AI benefits from greater network effects than other businesses because there is scope for corporate alliances on server data, in order to train cyber threat detection AIs on attacker behaviors from a network of companies. These alliances are already effectively being brokered by continuously training models like Singularity's from lots of clients. Cybersec has always been rather underinvested relative to the possibility of cyber threats. We think there's way more secular room to grow for the industry, and for SentinelOne as an emerging player within it. A 2.4x multiple is low considering the growth rates and theoretical profitability. If they 3x sales in a couple of years and achieve 25% EBITDA margins, they'll be trading at a 4x EV/EBITDA. That seems way too low.

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