Sentinel...Not#1

@wsm007 this is extremely helpful…I want to appreciate you explaining rationale to purchase and sell.

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Of course I’m not speaking for Saul, and I’m interested to hear his thoughts (just as I was interested and impressed to hear wsm), but in the spirit of the ‘office pool’ my money is that Saul sold his entire position without a second thought in the after-hours Thursday. It’s one of the remarkable things I admire about his strategy, his ability to cut and re-allocate when the conviction turns.

I myself still can’t bring myself to sell 100% of my position when I feel I got beat by the algorithm. Sold some, sold some more this morning, and I’ll wait until there is some technical recovery (not allowed to elaborate here per board rules) to offload the last tranche (Yes: I’m of the opinion that there will be some recovery in the near term that is better than just cutting my losses entirely and re-allocating what I have left across other positions. Sometimes it works, sometimes it doesn’t (past experience with UPST, LSPD, AMPL).

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Here’s my take. I’m not just out of Sentinel, I’m out of cyber security completely. As Kurtz said, “The market is fragmented” and that’s so true. The competition is fierce. ZS is one of the few in this area to have a good day. But Prince, CEO of Cloudflare says that they are competing with a network zero trust offering. Is it as robust as ZScaler, I’m sure not, at least for now, but that doesn’t mean Cloudflare is out of the competition. And actually it’s probably not even very relevant. So long as the average retail investor thinks it’s competitive, the stock price will follow the sentiment.

To be honest, I was not as perceptive as @wsm007. Even though it’s right there in the name Annual Recurring Revenue, I didn’t immediately put it together. But the fact that they were restating past performance along with future guide, the fact that they admitted to counting eggs rather than chickens was sufficient for me to bail.

Initially I thought I’d put the money into Crowdstrike. But after giving it some more thought, I decided that I just didn’t want to hold any cyber security shares.

I’ve come to the conclusion, painfully and late, that the whole segment is just not where I want to be invested. There’s lots of other companies that I have more confidence in than any of cyber security companies. Even though every corporation (well most anyway) put cyber security as a top priority, it’s pretty hard to determine which security company will benefit sufficiently to grow fast enough to be the company I want to invest in.

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Well, I had a 12.5% position at the end of the May, and I have a 3.9% position now, which is less than a quarter the size, so I guess that that answers your question.
Saul

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Saul, it looks like you sold a little more than half of what was left after the drop. Is that because you still have confidence in the company?

Management has lost credibility and will be tested the next couple of quarters. If they prove themselves, Sentinel could recover nicely. Though I see why many don’t want to wait for eggs to hatch.

I’m still sitting on a 6.64% position.

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I posted this back in March:

"Something else to consider. One of the largest Sentinel shareholders was Dan Loeb (Third Point LLC). If you followed the Upstart saga, you might remember he was one of the largest investors there also. He sold all his UPST shares during the drop from the major pump. He appears to be in the process of doing the same thing with S.

Here is the number of shares he reported owning at the end of each quarter over the last year:
2021 Q4 - 26 Million
2022 Q1 - 26 Million
2022 Q2 - 21 Million
2023 Q3 - 19 Million
2023 Q4 - 10 Million

One of the largest investors is cashing out with the stock at very low prices. This amount of selling is surely a big part of what is keeping the price down."

FWIW - Dan Loeb now owns zero S. Was an early investor and sold out completely near the lows.

Stock is near all time low when other growth stocks have bounced back 80% - 100% from lows.

Now they are not going to be fcf positive until 2025 - if you believe them on that. They will probably need to do a capital raise at some point - with very low stock price. Continually lowering stock will make it hard to hire and retain people. If you were a major corporation, would you want to invest your security in a company that is probably going to be struggling to hire and retain talent?

Look at that volume bar from Friday. If the stock price breaks below the pink line, I would not be optimistic.

wsm007 - thank you very much for your explanation. I would not have understood any of that if you had not taken the time to write it out. I am less charitable than you - I assume they knew exactly what they were doing.

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Liquidating 26 million shares over a bit more of a year… isn’t going to have a big effect on the stock… considering daily volume is nearly 8 million.

Performance of the company has been the drag on the stock. Company performance having an effect on stock performance? Who knew? :wink:

Rob
He is no fool who gives what he cannot keep to gain what he cannot lose.

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"One of the largest Sentinel shareholders was Dan Loeb (Third Point LLC). If you followed the Upstart saga, you might remember he was one of the largest investors there also. He sold all his UPST shares during the drop from the major pump. He appears to be in the process of doing the same thing with S.

Here is the number of shares he reported owning at the end of each quarter over the last year:
2021 Q4 - 26 Million
2022 Q1 - 26 Million
2022 Q2 - 21 Million
2023 Q3 - 19 Million
2023 Q4 - 10 Million"

I should have been paying closer attention to that. It would have saved me serious loses in SentinelOne.

One of the patterns that I have learned over the years is that it’s not always good to follow Loeb into a stock, but when he sells down on his way out of a position, wherein he had accumulated a hefty stake, it is among the most reliable indicators that I know of that the story is about to unravel. Off the top of my head are not only Upstart that you mention, but also CANO health. There was another that impacted my investments but I can’t come up with it at the moment.

In each case that I know about, he had lost confidence in the company leadership.

When/if S leadership reprices options for executives, it should remove all doubt that Weingarten, brilliant as he is, has a value system that does not place his fiduciary responsibility to all shareholders front and center. Excess executive compensation has been out of line all along, and now poor sales execution and accounting restatements uncorked out of the blue.

Anyway, following Loeb out of a stock has seemed like a good idea from my experience. That’s not always true with other gurus. For example, Buffett sells are often followed by a durable rise in the stocks.

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Rob,

The “reported” performance of the company was pretty good until the ER 2 days ago - that is why many here owned it. But the stock has been going down for the last 1.5 years in spite of that good performance.

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Hmmm… I guess that’s where the word “performance” has different meaning for different people. I’ve shifted to looking for companies that make money.

Some folks claim…personally, I’m not sure… that the market has been looking for the same thing and “those folks” (reported in articles) claim that’s why many money losing companies have lost market value. Just rumor perhaps…

Rob
He is no fool who gives what he cannot keep to gain what he cannot lose.

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Good points have been brought up as to why this was a bad quarter - the market obviously agreed and took the price down by 35%.

I can understand why investors are running for the exits, the drop however is very harsh, which is why I opened a speculative position in $S on Friday (may change my mind as new data evolves). I agree with a lot of the comments, though here are some things I considered before opening the position:

  • This marks the first quarterly miss for $S since becoming public

  • Post full year guidance reduction, the growth is now forecasted at 42% and therefore still the highest full year guidance across all companies. Since consumption was entirely removed from ARR, any uptick in consumption will create tailwinds for revenue.

  • SAAS companies which previously guided aggressively are taking the guide down too. $SNOW from 50% to 40% to 34% -, $GTLB from 40%+ to ~25%, and even more predictable companies like $NET from 38% to 32%). It’s not isolated to just $S.

  • EV/NTM Revenue is now approximately 4.6x (~$702M Revenue & reduced cash of $718M). So a steep discount, though it could get cheaper should we not see a floor on growth slowdown.

  • Is it completely unreasonable to include “predictable consumption revenues” into ARR? it worked in the past, however it does not seem to work in this macro. One thing to watch is if these consumption slowdowns also lead to customer retention issues.

  • The change in calculating ARR and affected underlying metrics could have created a lot of confusion (basis for price algos determined). One example is the growth for 100K customers. This quarter includes the new calculation method, and therefore it needs to be compared against reduced previous reported numbers. If we subtract 5%, last quarter would be 859, for a net add of 58. That is still a significant slowdown, but not as bad as 12 added. The algos could have just taken 12, and this metric is extremely important for future growth projections. You can see this discrepancy when looking at their reported YoY growth of 61% for 100K customers vs what looks like 55% when compared against the previously reported number of 591 (Apr 2022).

  • The customer growth did see acceleration in Jul 2022, eg. QoQ growth for 100K customers went from 13.7% to 27.7% (organic excl. Attivo might have been closer to 19%). I’d be curious what Jul 2023 looks like factoring in some seasonal slowdown in Q1 and deal slippage specifically called out for this quarter (are deals closing in Q2?). This metric really needs to start improving ASAP!

  • Crowdstrike stopped reporting customers alltogether as of this quarter, they would not be doing this if it was favorable.

  • The rapid shift towards improving FCF margins hurts smaller companies proportionally more. $CRWD is a well oiled machine, and the FCF margins are a lot more steady (~30-35%) as compared to $S (-70%-90% to -24%). This was one of the reasons I felt $S had no margin of error priced in prior to earnings. It’s a real challenge to drive such change through the organization while maintaining hypergrowth.

  • Yes management made rookie mistakes - though it is a lot harder to run a company that has been performing like a speedboat, and now needs to reverse course and pump the brakes.

  • The company has no debt, $1.1B in cash & path towards FCF breakeven looks achievable (while more at risk).

  • It’s a tough one, but I am not yet convinced the long term thesis is broken, and at the current price I felt a lot of uncertainty is accounted for.

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Great thread and I personally find your take very well thought out, @wycap.

I had S on top of my short list until this report but was put off first by the speculative run in the shares from around 14-15 to north of 20 and then by the report itself.

I guess the glass half full thesis has to do with the quality of the product. Back in 2021, a respected product analyst argued that S has the best performing product but that because it deploys the agent on each endpoint, it is a much more operationally cumbersome approach than CRWD’s lightweight one.

In Dec/Jan, I wondered why there was no reported (unless I missed it) takeover interest in S when the market cap was at about current levels.

If the product is that great and the company that cheap, why not buy it out?

If the product is that great, why is not S leading the way among the largest/deeper pocketed enterprises (or maybe it is and I missed the memo)?

I think this question applies even better to the current situation.

A high-quality product alone won’t prevent a company from failing but it should generate buyout interest. And if it does not, is the product really all that great?

So 2 years later, what do we know about the actual quality of the product vs. the competition in the context of real-life operations as opposed to hypotheticals benefiting one or another player?

EDIT: specifically,
if I am a large business, what is the S edge over everybody else, if any?
if I am a small business?
If I am a government institution or non-profit?

For me, I feel that I need to know the answers to such questions before considering S a bargain bin diamond.

And then I would also need to formulate a thesis about management being able to learn and move on.

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Thanks & agreed here @MAS4R - had I owned the shares prior to earnings I would have been inclined as well to hold on or conversely close any shorts during the run-up. The relative strength was very impressive, and it all seemed to prepare for the next move higher.

On the product side I think it would have been impossible to ramp up to over $500M in run rate, at such a rapid clip, with best in class retention rates - had it not been for a competitive product. Such performances are extremely rare, and I do believe it’s only possible with an exceptional product market fit & execution. Obviously $CRWD is taking $S seriously and they are trying to make their life more difficult at every level. My best guess is that $CRWD could have a more complete offering, based on the total effort going into R&D, as well as longer tenure in market. Perhaps $S built a better mouse trap in some important areas that resonate well with the market (e.g. more automation with respect to threat detection). But I really don’t know what the exact strengths/weaknesses are of both of these platforms - and it’s certainly possible that $CRWD has stepped up their game as $S became larger.

On the acquisition side it’s hard to tell whether there was inbound interest - and what Sentinels position was/is. Prior to macro conditions deteriorating the business was firing on all cylinders and a strategic deal could have been pre-mature. If there is any interest currently, perhaps it would be a good time to have discussions. Imagine if Microsoft acquired $S, they would compete head to head against $CRWD and could advance the product to the next level as well. Maybe even a legacy provider that is behind on the cloud, or if companies like $ZS/$NET if they want to expand their product portfolio.

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I run ZS and S on my laptop. The view from my IT group is that CRWD is the premiere solution but it requires infrastructure (people) to support it. Thus small companies like ours prefer S. But large enterprises prefer CRWD. It seems entirely plausible that smaller organizations are under more pressure in this downturn than large. Thus S is harder hit. It may not be that their products aren’t competing, it could be more that the segment of the market where their product is best positioned is under more pressure.

I have never been invested in S, but considering an allocation. Upside could be large if they can cross over to cash flow and continue to rapidly grow.

Rob

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Thanks both @rhill0123 and @wycap for your great replies.

@rhill0123 that tidbit is especially helpful. I was wondering why CRWD would be preferred by bigger companies if S is the “superior” (protection capability) solution, as the product analyst I had in mind claimed. If enterprises are a good measure for this, CRWD seems to have the edge.

But I am also with @brittlerock on this. I will keep S on my watch list but I doubt I will return to an endpoint company due to the fragmentation and competitiveness of the space. ZS is the most likely one for me in this area when I decide I want a greater SaaS exposure again.

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Take a look at $GTLB - that stock got taken to the woodshed last quarter (-25% on earnings and even to -40% thereafter) on the highest volume ever traded (just like $S). And now it recovered all of its losses in a few seconds AH. It’s interesting how quickly sentiment changes. $GTLB is now guiding to 28% growth, and is trading ~10x NTM revenue (2x the multiple of $S). However gross margins (90%) and FCF (-9%) are significantly better.

I’m not saying this is what will happen to $S as well, but sometimes the price action gets quickly reversed with new facts emerging. Full disclosure I own both of these companies and I added more to $S today.

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Here are my notes from the Sentinel One: Bank of America Securities Technology Conference that ended a moment ago.
06/06/2023, 3:20 Central Time

Tomer Weingarten, CEO
David Bernhardt, CFO

Q Color around how you won’t do this (quarterly revenue/guidance miss) again
A ¼ previous ARR will become revenue, but this doesn’t make up the revenue shortfall. Did we miss something that should have come through, but it didn’t. Next was consumption swings that were elevated in previous quarters, and that was a part of it, but that didn’t make up all of the miss. Is there anything in the ARR that would have led us to believe we should have had revenue as projected? Turned out to be $13 to$14 million off.

Q What drives the decline in ARR miss? Competitive?
A 50% was miss of from previous quarter’s ARR. Towards the end of last year (Q3), deal elongation. Missed a couple of things. Didn’t think they’d see this level of reduction in consumption. The other thing is in their own operating philosophy. Consumption was always there and they won’t do things their competitors have done. They don’t go after each other’s customers, etc. When we put our technology in front of customers, we win. We need to get better at changing that narrative and S’s maturation into a platform company. Definitely maturing so their sellers can sell a platform. Massive market opportunity and want to continue and build beyond endpoint. Other opportunities in Cloud and Security data lakes while continuing to deliver meaningful revenue in endpoint.

Q Price as a factor and competitors who are committing suicide with pricing.
A Price matters a lot and companies are doing work with zero dollar deals. We don’t do lost profit deals. Companies who have already milked their network deals, as they’ve seen with MSFT. S is doing a better job of showing the hidden costs that are really tangible line items for the CFO’s. It’s not sustainable or healthy for customers or providers.

Q MSFT bundling
A Going to have to articulate the hidden costs of doing business with MSFT and the technology positioning with S and other pure plays. MSFT is not a security platform, it’s a bundle of a bunch of software products. Offerings outside of endpoint such as security data lakes, identity, EDR approaches, etc. don’t mesh, talk and/or work together.

Q How do you manage to compete in the market being a smaller company. You are more focused but you have state of the art technology. Where are use cases where customers say I need you in spite of your size?
A There is a balance there between getting the care in the technology. It’s different with the pure plays. We’re reaching bigger and bigger scale, and yes it is more difficult for us as a smaller company. Our financial viability is as good as any others. We don’t have the same reach, marketing budgets, exposure and resources. Only been a public company for a couple of years. Our technology is by far better than the competition. Right now it’s not an easy environment.

Q One of the biggest risks is investment sensitivity.
A Everything they’ve been doing has been focused on FY 2025. Guiding in the 25% to 29% earnings growth. Looking at areas of the company that they needed to reinvest in rather than spending some of their budgets where they were previously. They’ve been really tight (with budgets) and focused on expenses. Gross margin going into the IPO was 50% and now it’s 75%. Everything they’re doing is to get to that margin profile of break even.

Q Of the +/- 10 modules you sell, where are you seeing your focus and the future growth?
A Identity, security data lake, cloud, It is about fundamentally changing how you think about security rather than endpoint. AI can give you the data to automate your environment. The attackers are out innovating the security companies with AI/LLMs. This is the most dangerous piece from which to protect users.
Note: I joined the call +/-10 minutes after the call began, so there may have been additional content that was stated by the CEO and CFO.

sjo

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This note from JP Morgan explains the strength in $S shares - it’s now my 3rd largest position.

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I’d like to provide some additional insights into the customers.

Here are the updated numbers for customer spending > $100k for the past quarters, after the methodology change:

image
Source: 10-Q

Are 45 net new adds (5.2% QoQ) vs 49 (9.4% QoQ) a year ago, good or bad for S?

Unfortunately, I can’t compare them to CRWD, since Crowdstrike doesn’t report customers anymore (and never reported a $100k cohort).

Comparing it to ZS’s $100k+ cohort: 95 net new adds (4.3% QoQ) vs 140 net new adds (8% QoQ) a year ago, it makes the development look solid for Sentinel One since Zscaler shows a similar weakness for customers spending more than $100k ARR - and the lowest amount of $100k customers since almost 3 years.

Comparing it to DDOG’s, $100k customer cohort (although it’s not apples to apples): Also their lowest in the past 3 years: 130 net new adds (4.7% QoQ), vs 240 net new adds (11.9% a year ago)

Furthermore, it’s worth noting, Sentinel One added 1 net new Fortune 10 customer, now serving half of them:

Walmart, Amazon, Apple, CVS Health, UnitedHealth Group, Exxon Mobil, Berkshire Hathaway, Alphabet, McKesson, Chevron.

My takeaway: When considering other companies’ performance in the current environment, customers for Sentinel One aren’t falling off the cliff, and make these results look rather encouraging.

mooo (@MoritzMDrews on Twitter)

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Where did you see 49 from last year?

I think a key part of the thesis for SentinelOne was that they would grow significantly faster than Zscaler or Crowdstrike or Datadog since SentinelOne is so much smaller. One reason it was key is that SentinelOne needs to grow fast just to become profitable. They’re still burning a lot of cash, and diluting shareholders rapidly. Growth rates coming down for profitable companies like Crowdstrike etc…that’s not the end of the world. But SentinelOne can’t continue to grow slower and slower, or they’ll never reach profitability. So to answer you I would say the slow down to 5.2% QoQ is bad for SentinelOne.

Bear

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