SentinelOne: A Closer Look Into The Hypergrowth Cybersecurity Company (S)

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Investment thesis

SentinelOne (NYSE:S) is a good candidate for someone looking to invest in a high growth company that is in an industry with strong secular tailwinds like the cybersecurity industry. The company has great prospects as it looks set to increase its market opportunity as it can expand into tangent market opportunities, while also increasing penetration in its endpoint security market in the near-term as it continues to gain market share from the incumbents. Furthermore, I think that SentinelOne’s technology is top tier in the endpoint security space and this will drive further share gains, in my view, as it provides a strong value proposition to its customers as the most technologically advanced and innovative company in the endpoint security space.

Overview

Having been founded in 2013, SentinelOne is in the business of providing its customers cybersecurity solutions and its platform is mainly focused on endpoint security. It aims to automate the security process of protecting, detecting and responding by leveraging on its distributed artificial intelligence model. The company continues to add to its opportunity set and expand beyond endpoint security into other related segments like cloud workload protection, Extended Detection & Response (“XDR”), amongst others.

Expansion in market opportunities brings huge addressable market by 2025

I think that the opportunity set looks rather interesting for SentinelOne. Its current endpoint security market, which comprises of both endpoint protection platform and endpoint detection and response, currently has a total addressable market of $11 billion. The crucial point is that there is a sizable legacy vendor presence that SentinelOne can disrupt and penetrate, in my view. The company currently has a rather small penetration rate of just about 1% today and I think that we could see share gains to about 3% to even 5% market share in the next 3 years to come. As can be seen below, legacy players have seen market share decline from 31% in 2017 to 23% in 2020 as newer players with innovative technology like CrowdStrike (CRWD) and SentinelOne gains market share.

Falling market share of legacy players

Falling market share of legacy players (UBS)

Other than the existing opportunities in endpoint security, there is an additional, broader total addressable market of $44 billion by 2025, if SentinelOne expands into tangent business segments like security analytics, observability, IT operations and security operations. As a result, I think what this expansion in total addressable market mean for SentinelOne is that we could see future upsell opportunities for the company as it expands to complementary and synergistic business segments. XDR, as well as cloud security and internet of things are areas that can significantly increase the platform scope in the future, in my view. As can be seen below, according to SentinelOne’s guidance, we could see its total market opportunity increase significantly by 2025.

Market opportunity in 2025

Market opportunity in 2025 (Gartner)

Strong technology key to future share gains

The key to doing well and expanding market penetration in its existing endpoint security market is to have strong technology that brings material differences to customers. This is where I think SentinelOne stands out amongst its peers. First, industry benchmarks indicate that SentinelOne is among the top of its field. Gartner Magic Quadrant upgraded SentinelOne from the “Visionaries” quadrant in 2019 to the “Leader” quadrant in the endpoint protection platform segment. This move up shows the progress in the recognition of SentinelOne’s technology as being a leader in the industry. Second, SentinelOne ranked among the top for the MITRE ATT&CK Evaluation which measures vendors ability to automatically detect and respond to real life cyberattacks. It is amazing that SentinelOne was about to deliver 100% protection, detection, real-time and 99% visibility and analytic coverage. I think that these strong results demonstrate SentinelOne’s strong technological advantage that translates into real world advantages. This, in my view, will lead to further sustained share gains in the years to come if the company is able to sustain its technological lead.

In addition, through my industry conversations as well as conversations with management, I come to appreciate that SentinelOne’s security platform is often regarded on similar standards or even better than CrowdStrike, while at the same time, it is seen as superior to legacy players as well as other newer market entrants. One of the striking points that comes up often is the extent to which automation is incorporated into the SentinelOne’s security platform, ensuring higher levels of automation for the prevention, detection and response phases of endpoint security. Another common strength that SentinelOne brings is the strong functionality that its customers like. I think that while the competition may be tough in the endpoint security market, SentinelOne has a strong track record in bringing about innovation to continuously bring a differentiated offering to its customers.

SentinelOne’s patented distributed artificial intelligence model for prevention and detection is an example of a differentiated approach that the company takes which then allows for response to threats to be carried out more quickly and bring better capabilities for prevention. As such, I think that SentinelOne currently has an advantage when it comes to autonomous prevention compared to peers, even though other competitors like CrowdStrike and other newer entrants are attempting to utilize a similar framework.

Potential growth from new customer additions

Currently, SentinelOne only has 8,600 customers, compared to the 19,686 customers that its closest competitor, CrowdStrike, currently has. This does demonstrate further upside to potential new customer additions if SentinelOne can continue to attract new customers. As such, I am of the view that new logos can be the driver of future growth as more companies come to realize the value add that SentinelOne brings.

In addition, we are seeing larger deals for SentinelOne. The company announced that in the current quarter, they won their largest contract in their operating history, one with an eight figure multi-year deal with a large multinational company. While this may just be one deal and the first of its kind, I think that this is the type of narrative that investors need to see to gain confidence in SentinelOne’s offerings and platform’s ability to win over the large enterprises and bring in increasingly larger and higher ARR per customer.

As such, with these two upside scenarios that can be leveraged on, I think that the hypergrowth profile of SentinelOne can be sustained in the near-term as it can leverage on these two opportunities as well as its innovative and strong technology to gain market share.

Solid 2Q23 results

For the recent 2Q23 report of the company, I think that it shows that the company continues to gain market share and demand remains to be strong as revenues continue to beat, and margins came in as a positive surprise. ARR growth for the quarter was at 122% year on year to $439 million. This was a result of both strong renewal rates, evidence of upselling of its existing customers, as well as strong customer demand for SentinelOne’s solutions

Dollar-based net retention revenue for the quarter also came in at a new record of 137% compared to the long-term target of 120% as the company has achieved consistent acceleration across the past 6 quarters. The key drivers of this improvement comes from increasing of deal sizes as well as increasing new and existing adoption from customers as SentinelOne managed to successfully cross-sell more of its modules. I think that given the strong beat of the net retention revenues over its long-term target, SentinelOne could see continued strong net retention revenues above 130% in the near-term as more modules are adopted and current customers continue to expand on the platform.

In 2Q23, SentinelOne also saw rather decent net new customer adds of about 1,100 with 350 coming from Attivo. I think what is more encouraging is the increase in customers with more than $100,000 in ARR increasing by 117% year on year, surpassing the average growth in customer count of 60%.

SentinelOne saw gross margins improve by 10 percentage points to 72% in the quarter. This also helped to contribute to the improvement in operating profit margins as it improved 42 percentage points year on year. The reason for the improvement in both gross margins and operating profit margins were a result of scale benefits, increasing efficiencies and rising customer adoption. While the operating margins are still rather sizeable at -57%, I think that this improvement in the margin profile showed management’s discipline on expenses as well as the effects of improving economies of scale for the business.

Lastly, guidance for revenues for FY2023 was raised from the range of $403 million to $407 million to the range of $415 million to $417 million, resulting in the year-on-year number increasing by about 4 percentage points. That said, gross margins and operating margins guidance are only raised by 1 percentage point.

Valuation

I value SentinelOne based on an equal weight DCF method and EV to Sales to Growth ratio method. My DCF assumptions includes a discount rate of 10% and terminal exit multiple at 9x 2025F multiples. For the EV to Sales to Growth ratio method, with an expected 70% CAGR across the next few years, I assume an EV to Sales to Growth ratio of 0.2x.

Blended together, I have my 1-year target price at $35.40, representing 62% upside from current levels. I think that the multiples are justified given SentinelOne’s hypergrowth rate that, in my view, can be sustained in the near-term, as well as its strong technology and long-term growth runway.

Risks

Sustainability of the high growth rate

Given that for most of SentinelOne’s time as a public listed company it has shown a high growth rate profile, if this high growth rate tapers off drastically, this could affect the sentiment on the stock. If SentinelOne does not continue to execute well to generate sustainable high growth rates or if it does not continue to spend on research and development to drive innovation, we could see growth rates slow down faster than expected.

Margins risk

As SentinelOne’s gross margins are still relatively lower than industry peers because of the storage levels that the company provides on its platform, which is rather costly. Apart from gross margins, there remains to be some debate on the continued cash burn we are likely to see for SentinelOne as well as the continued high spend on sales and marketing. I think that this poses a risk as management will need to continue to spend and remain committed to high levels of investment to continue to grow its platform and improve its solutions. As a result, there is a risk that the company may take longer than investors expected to turn profitable. Given that non-profitable technology companies are experiencing a risk-off sentiment right now, this could reduce the risk appetite for SentinelOne as it continues to take time to reach positive free cash flows.

Competitive pressures

Competition for SentinelOne comes from the legacy players in the endpoint security market, as well as the newer market entrants. One of the competitors I would highlight from the legacy space is Microsoft (MSFT), which may not have the best-in-class security offering, but its wide range of solutions it offers to customers is definitely a catch and may pose as a risk for future market share gains for SentinelOne.

Conclusion

SentinelOne has an exciting roadmap ahead of it as its total addressable market is expected to grow over the years as it targets new opportunities. Furthermore, I am of the view that we will likely see material share gains in the near-term as SentinelOne gains market share from legacy vendors in the endpoint security market. To achieve this, the key for SentinelOne will be to ensure that it brings the best technology to the table, which means that for the company’s offerings to be best-in-class, it needs to continue to invest and innovate. Also, with potential for new customer additions as well as increasing deal size, I think that the company’s hypergrowth profile can be sustained in the near-term. Furthermore, despite certain market concerns for SentinelOne and the overall software space, the company delivered beat in revenues and even gross and operating margins as growth continued to be resilient in what some would consider a weakening environment. My 1-year target price for SentinelOne is $35.40, representing 62% upside from current levels.

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