# Sentinel One – A thought experiment

Sentinel One – A thought experiment

Sentinel One is a new forthcoming IPO company challenging Crowdstrike. It may be difficult for you to actually grasp how horribly bad their business figures are!

Based on the figures Gaucho Rico just presented, they have an operating margin of minus 127%. Now that doesn’t mean that for every \$100 million in revenue they take in they are spending \$127 million! Oh, No! That means that for every \$100 million in revenue they take in they are spending \$227 million!!! They are thus losing \$127 million.

Now their gross margins are 53% which, by definition, means they are spending \$47 million as the cost of every \$100 million in revenue.

With me so far? That means their operating expenses are \$180 million for that \$100 million in revenue (47 plus 180 equals 227).

So what happens this next year. Let’s say they grow by 100% and double their hypothetical revenue to \$200 million. And improve their gross margins from 53% to let’s say 56%. And let’s give them rapidly improving metrics and say they grow revenue by 100% but only grow operating expenses by 75%. What do we have?

Cost of revenue is 44% of \$200 million or \$88 million

Operating expenses are 175% (75% growth) of last years \$180 million, which comes to \$315 million.

315 plus 88 is 403, so their total expenses are \$403 and revenue was \$200. So this year, although doubling their revenue they are now losing \$203 million, up from last year’s \$127 million.

It’s an eight-ball very difficult to get out from behind. Sure they can say, “We improved our operating margin from minus 127% to minus 101%” but so what? They are losing 60% more money than they lost last year. That would probably mean big secondary to raise more cash to feed the money-losing business, and lots of dilution.

And you can do the arithmetic for the year after for yourself, figuring 90% growth, 59% gross margins, etc. It’s not a pretty picture.

I hope that this helps.

Saul

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Thanks Saul.

Below is CRWD’s non-GAAP operating margin history for each quarter going back 3 1/4 years. SentinelOne’s ARR (which is a measure of how much total cumulative recurring revenue business the company has captured by the end quarter) was a similar size (at the end of April 2021) to CRWD’s ARR on 31Jan 2019. But CRWD’s operating margin was not -127% but only -35%. And CRWD was growing faster then. And CRWD had higher gross margins then. CRWD was a much better company when CRWD was SentinelOne’s current size.

``````
31Jan18  -92%
30Apr18  -66%
31Jul18  -50%
31Oct18  -43%
31Jan19  -35% <<<<CRWD's OpMar at SentinelOne's current size by ARR
30Apr19  -23%
31Jul19  -19%
31Oct19  -13%
31Jan20   -4%
30Apr20    1%
31Jul20    4%
31Oct20    8%
31Jan21   13%
30Apr21   10%

``````

GR

73 Likes

I revisited Saul’s post No. 77828 after SentinalOne recently posted their Q3 results to see the developments in the numbers.

Non-GAAP Operating Margins have improved considerably from:
-127% (Q1) → -98.3% (Q2) → -69% (Q3)
So now for every \$100 million in revenue the Company is spending 169 million i.e. they are losing 69 million; compare this Q1 when they were losing 127 million – so that loss is almost halved in just 2 quarters.

Non-GAAP Gross margins have also improved:
53% (Q1) → 62% (Q2) → 67% (Q3)
So now they are spending 33 million as the cost of every 100 million in revenue.
This means that operating expenses are 136 million for that 100 million in revenue (33+136 = 169)

Revenue growth over the past 6 quarters has been accelerating (with the exception of Q4, 2021):
96% (Q2, 2021) → 103% (Q3, 2021) → 97% (Q4, 2021) → 108% (Q1, 2022) → 121% (Q2, 2022) → 127% (Q3, 2022)

QoQ growth has been above 21% the last 4 quarters, and in Q3 2022 it was 22.3% which is a run rate of 124%. So I expect growth to continue to be above 100% for the next four quarters. So in line with Saul’s post let’s say they grow revenue by 100% next year, that would give a Q3 2023 revenue of 112million.

In Q3 2022 revenue was 56 million; with 69% Non-GAAP Operating Margins that means that for the 56 million the Company spent 95 million.

With Non-GAAP Gross margins of 67% this means that they spent 18.5million to achieve that revenue of 56 million.

This means that operating expenses are 76.5 million (18.5 + 76.5 = 95)

In Q3 of 2023 If they continue to maintain existing gross margin of 67%, and grow operating expenses by 75% then we would have:

Cost of revenue would be 33% of 112million = 37million

Operating expenses would be 175% of 76.5 million = 134 million

134million + 37million = 171 million, so the total expenses would be 171million for a revenue of 112 million. So doubling the revenue by Q3 2023, they are losing 59 million, which is less than the loss this year of 69 million.
If they continue to improve their Non-GAAP Operating Margins then this will further reduce operating expenses, resulting in an even smaller loss.

It would seem that the numbers are trending in the right direction.

I hope my math is correct!

13 Likes

Hi Money Spin, I think you missed one statistic. Looking at dollars of loss, instead of percent of loss:

Sentinel’s loss from operations was \$38.7 million this quarter, compared to \$25.1 million for the same quarter a year ago. So they are losing more money than a year ago, 54% more money actually, although the loss is a lower percent of revenue, because revenue has grown even faster.

(Revenue was \$56.0 million this quarter, while a year ago revenue was \$24.6 million).

So if you are investing in Sentinel you are investing in their growth rate, not with any hope of profitability any time soon. Nothing inherently wrong with that, as long as the growth rate holds up.

best,

Saul

45 Likes

I really enjoyed delving a little deeper into the metrics of a SaaS company following this post:

I decided to seek out the blog written by David Skok:

https://www.forentrepreneurs.com/saas-metrics-2/

The suggestion is that as SaaS companies chase customer acquisition, the more aggressive it is the worse the financial position of that business is going to be, however, the more exponential the growth rate following the acquisition; should the business be able to keep DBNRR high.

I agree that the financials of SentinelOne do not make for great reading, but should they keep a DBNRR of 130%, as customer acquisition cost start to decrease, and revenue growth remain elevated should we not see significant upside?

So the bet here is:

1. Maintaining the revenue growth rate
2. Continued positive trend of costs
3. Maintenance of the 130% DBNRR

I think my logic is relatively sound, assuming the theory is correct.

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It is the norm for losses in dollar terms to continue to go up until they get to a point they show business scale. CRWD showed larger losses each year 18 through 20 then in 21 their operating loss improved. Their gross margin also improved all through that time.

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Sentinel’s loss from operations was \$38.7 million this quarter, compared to \$25.1 million for the same quarter a year ago. So they are losing more money than a year ago, 54% more money actually, although the loss is a lower percent of revenue, because revenue has grown even faster.

To put things into perspective, although S lost 54% more money than a year ago, their revenue was 128% more than a year ago, and what’s more, their Gross Margin dollars was 163% more than 1 year ago!! (GM improved from 58% to 67%!!) I do believe there was a huge operating leverage here.

I think FCF margin is an even better indicator - it was -37% in Q3 2021, massively improved from -80% a year ago and -97.6% last quarter. I think Q2 didn’t show good operating leverage was mainly because of IPO cost.

In fact, at similar ARR, both SNOW and CRWD had similar operating margin and FCF margin.

Rubenslash provided CRWD’s metrics at similar size below:
https://discussion.fool.com/sentinelone-q3-and-comparison-to-39e…

And SNOW’s Q3 2019 (the earliest I can find) revenue was 73m which was much larger than S’s Q3 revenue 56m, their non-GAAP operating margin was -93% and FCF margin was -39% (both much worse than S). But we know what happened after that.

Long SentinelOne with 13% position.

Zoro

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I ran 25 companies through 6 and 9 quantitative rankings and then also through my perception of CEO, product, etc. Sticking to the first of these rankings, 6 numbers, S scores like this:

-QoQ sequential revenue growth: S came 2 of 25 behind only SNOW which had unexpected usage due to certain customers working on specific projects.
-YoY revenue growth: S came 2/25 to UPST
-Gross Margin: here S is 20th
-non-Gaap operating Margin: here S is dead last far behind CFLT and ASAN, which share 23rd place.
FCF margin: S is second to last ahead of only ASAN
Cash&Eq - LTD Here S is 7th with more than 1.5B more cash than LTD.

Overall across the 6 metrics the ranking came out as follows even though I use double weighting for sequential growth where S excelled.

1. UPST, by far first

2. SNOW

3. ZS and MNDY

4. DDOG

5. RBLX

6. DOCS

7. CRWD

8. ZI

9. PATH

10. S

11. NET

Speaking of comparisons against CRWD, the similarities in revenue trajectory are extraordinary as in gross margin, but S is one quarter behind on op margin:

CRWD revenue 39,000 47,000 56,000
S revenue 37,400 45,800 56,000

CRWD -92% -66% -50%
S nG op mar ? -98% -69%

CRWD gross mar 51% 59% 67%
S gross mar 51% 59% 64%

Whether I like it or not, I own S indirectly in my limited-to-ETFs 401k. I own ZS and CRWD both directly and indirectly, in fact these two account for about 10% of my total net worth.

35 Likes

“So if you are investing in Sentinel you are investing in their growth rate, not with any hope of profitability any time soon. Nothing inherently wrong with that, as long as the growth rate holds up.” Looking at the YoY numbers this is certainly true. But are the numbers of the last three quarters telling us a different story?

If you look at the dollar of loss over the past three quarters (Q1-Q3 2022) they look like this:
-47,50 (Q1) → -45,00 (Q2) → -38,70 (Q3)
Dollar loss is decreasing QoQ

[Note: Contrast this to the 2021 where the dollar loss was increasing QoQ:
-22,58 (Q1) → -20,97 (Q2) → -25,09 (Q3) → -30,97 (Q4)]

While the revenue over those three quarter (Q1-Q3 2022) was increasing about 22% QoQ:
37,30 (Q1) → 45,80 (Q2) → 56,00 (Q3)

Losses as a percentage of revenue Q1-Q3 2022 is decreasing QoQ (and YoY):

127% (Q1) → -98% (Q2) → -69%

[Note: Contrast this to the 2021 Q1-Q4 where the losses as a percentage of revenue was relatively stable around 100%:
-126% (Q1) → 101% (Q2) → 102% (Q3) → 103% (Q4)]

So over the last three quarters (Q1-Q3 2022)the numbers are telling us: revenue is growing revenue (>20% QoQ) and they are moving towards profitability and the losses are a lower percentage of revenue because revenue grew faster.

Also, as Zoro pointed out FCF and FCF margins are improving dramatically both YoY and QoQ:
FCF margins look like this over the past three quaters:
-87% (Q1) → -97% (Q2) → -37% (Q3) (in contrast for 2021 the FCF margins decreased from 71% Q1, 2021, to -85% Q4, 2021)

Thank you all for the insightful discussions. Wishing you all the best.

(I do not hold a position in S)

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