SentinelOne Stock: At 43x Next Year's Sales, I'm Not Getting Involved Here

Summary

• SentinelOne is growing at a very rapid rate, so it's easy to be seduced here.
• And even though profits shouldn't matter at this stage, its rule of 40 stands at 23%, which is far from impressive.
• Investors are paying 43x next year's revenues, which is probably more than a fair multiple already for this stock.
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Investment Thesis

SentinelOne (NYSE:S) is a very fast-growing cybersecurity company, guiding for more than 100% growth rates. Also, it's recognized by Gartner as a Leader in Endpoint Protection Platform. But the problems are two-fold, that its path to GAAP profitability is many years into the horizon, and that the stock is priced at 42x next year's revenues.

From this valuation, SentinelOne will have to truly impress investors for the stock to re-rate much higher from this entry point.

Revenue Growth Rates Accelerate

Source: author's calculations; SEC Filings

SentinelOne is working off a very small revenue base, with fiscal 2022 guided for $190 million in revenues. Nevertheless, the pace of growth is astonishing. You can compare with other cybersecurity names to reinforce this insight if you wish. For instance, the crowd favorite, CrowdStrike (CRWD), is expected to grow at approximately mid-60s% CAGR this fiscal year, which is close to half the growth rate of SentinelOne.

And unlike countless other recently IPOed stocks, the guidance that SentinelOne put out last month actually points to SentinelOne accelerating its growth rates from last year. This is an impressive display, no doubt.

What's SentinelOne? Why Does it Matter Now?

SentinelOne is a cloud-based AI-powered cybersecurity company. As we've seen over the past year, there's been a shift in how cybersecurity companies operate at the threat detection level. SentinelOne relies on automation to monitor, contextualize, and analyze events.

It uses auto-deploy technology, which means that no new software deployment is required for SentinelOne to ensure that customers' digital assets operate in a protected zero-trust environment. That means no downtime for customers. That means no loss of revenues for customers.

One of SentinelOne's advantages is its ability to contextualize unstructured data. Think of it in this way, whether the data arrives in the form of an excel spreadsheet or social media tweet, it is very different and causes cybersecurity companies a lot of trouble.

(Source)

Next, SentinelOne is recognized as a Gartner Leader for Endpoint Protection Platforms, see above. SentinelOne is able to track and monitor threats, both in the cloud and on-premise by providing endpoint protection.

When looking for a healthy growing business, I look to see the pace of customer adoption. That for me is the one thing that I look to after weighing up a company's revenue growth rates.

(Source)

As you can see, SentinelOne doesn't disappoint, with the growth in customers increasing more than 75% y/y. Furthermore, SentinelOne's retention rate is at 129% which once again paints the company in a good light.

Typically you'd want to see 120% net retention rates or higher. Although, you don't want it too high either, because that implies that customers are getting too heavy a bill at the end of a year, and they'll probably churn out after a while. This is around the sweet spot.

Path to Profitability Leaves Much to Be Desired

(Source)

The biggest detraction from the bullish investment thesis is that SentinelOne's path to profitability is less than desirable. Not only are its gross margins low, at the low 60s% range, but it will be a long time until it reaches close to 70%. And investors will note this unimpressive gross margin profile, and price the stock to reflect this aspect.

Along these lines, we can also see that SentinelOne's non-GAAP operating margins are going to be firmly in negative territory for a while. It's very difficult for one to get excited to incur heavy losses for such a prolonged period of time.

To add context to this analysis, consider that for Q2 2022, SentinelOne's rule of 40 metric was 23%. As a reminder, companies that have high rules of 40 are typically viewed as higher quality and vice versa.

Source: CrowdStrike August 2021

For reference, you can see above CrowdStrike's rule of 40 as reaching 80% for Q2 2022.

On the one hand, SentinelOne does carry $1.7 billion of cash and no debt, giving it plenty of room to navigate while incurring losses. On the other hand, given that for H1 2022 it burned through nearly $80 million of free cash flow, it's reasonable to expect that for the full year SentinelOne will burn through at least $160 million of free cash flow.

(Source)

And this in turn implies that at some point soon SentinelOne will be having to raise some cash by diluting shareholders. At this stage of its operations, this is a more likely course of events rather than raising debt.

SentinelOne's Valuation - Sizzling Hot

SentinelOne is priced at 42x next year's revenues. That is probably a fair multiple for a company that's clearly guiding for triple digit growth rates, with exposure to the uber-hot cybersecurity market. That being said, given its unimpressive profitability profile, it's difficult to become highly enthusiastic and pay such a high multiple for stock that's probably going to have to dilute shareholders soon.

To add another dimension, consider that Zscaler (ZS) is priced at approximately 33x next year's revenues. Note, Zscaler's year-end is misaligned but halving the two estimates for its year-end you get this approximate number of its forward multiple.

Remember, Zscaler has for a while been one of the most expensive names in cloud security. To think that in comparison with SentinelOne, Zscaler is the cheaper stock is an eyebrow raiser.

The Bottom Line

It's not difficult to see the appeal of investing in SentinelOne. It's the new kid on the block. It's growing at more than triple digits and accelerating too. That being said, its profit margins are unremarkable. And its valuation is red hot.

However, the argument could be made that earlier in a company's lifecycle, it is better to pay a large premium for a company that's growing rapidly, as its runway can be very long. And to that I would counter by arguing that investors are already pricing in so many years of future growth that it becomes less compelling to new shareholders. It makes me think, how much more multiple expansion could I reasonably expect from this valuation?

In short, I'm finding better investment opportunities to deploy my capital into right now. Good luck and happy investing.

Analyst’s Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Comments

[Crowded Place]

the TAM for S is basically as large as CRWD's TAM. But S' ARR is only <200m...The runway is super huge. If they can achieve 80% CAGR for the next 3 year, then it'll be far less than 30x, where the high-growth peers are trading at.

[wsoyke]

@Crowded Place
So you're predicting phenomenal revenue growth, with low margins, and no share price growth for 3 years, likely dilution, then it will be valued similar to top shelf peers?
I'd pass on that. 100% revenue growth means little from such a small base.

[Crowded Place]

@wsoyke
yea... it really depends on how you look at their growth trajectory. I would say, for high multiple stocks, valuation should directly reflect the growth potential (LT CAGR), so it doesn't matter whether it is small or large in terms of EV/S.

I've already embedded the share dilution though.

[Rubenslash]

Why do you need multiple expansion at this growth rate? Even if the stock grows at half the revenue growth rate (= multiple contraction), you will see stellar returns.

[DeepFake AI]

S is overvalued and not best of breed.

[Kunlun999]

My comment on the previous S article is like a summary of your article.

[deadhead213]

Man! You must be very short on $S. Most of your commentary is pure fiction at best.