Over two quarterly reports (Q2 and Q3) now, Sentinel One seems to have “matured” it’s go-to-market strategy as well as it’s internal, fiscal, management approach. Both of these paradigm shifts bode well for the company and impressed me this week.
Topline growth? Check
Customer growth? Check
Margin expansion? Check
Expense reduction? Check
Cashflow improvement? Nope
Herein lies one of the biggest risks in this company today.
I believe that S has about 11 quarters of operating cash left…
- No headcount change
- No acquisitions
- No new financing via equity or debt issuance
Operating cashflow - The company requires about $60M of operating cash each quarter.
This is the average of the operating and free cash flow numbers from each quarter in 2022. You can derive a fairly similar number by subtracting the quarterly revenue from the total of SGA and R&D expenses.
They increased their headcount from 1,080 employees in Oct 31, 2021, to over 1,900 employees as of Oct 31, 2022 (Source: 10Q SEC filing). This operating cashflow run rate reflects what it takes to support their existing headcount and business operations.
Liquid cash on the balance sheet is $701M (and not the $1.2B number that was reported)
They put a major portion of their cash, $457M, into long term investments which are NOT liquid for at least one year. While I applaud this move, it increases the cashflow risk of the business.
- Q2 balance sheet showed $269M in cash + $950M in short term investments
- Q3 balance sheet shows $210M in cash + $491M in short term investments + $457M in long term investments
See their detailed financial maps here, including trendlines for each of the metrics:
Going back to the three assumptions above:
Headcount changes - Any measurable increase in headcount (say 10%+) will start eating faster into their cash balance. Labor (salaries, benefits, bonuses, SBC, commissions etc) is their biggest operating expense today (Source: 10Q SEC filing).
Acquisitions - Their most recent Attivo acquisition cost $617M. This included payment of $281M in cash and shareholder dilution via issuance of 100M additional shares.
For a relatively “young” company with less than $500M in annual revenues, it often imperative to grab as much marketshare and growth early in its lifecycle. It does this by acquiring new product capabilities or customers (by acquiring a competitor). SentinelOne might need to do one or the other or both in 2023, in 2024 and perhaps in 2025. These acquisitions are going to eat into its cash balance of $701M and will likely increase shareholder dilution, thus putting pressure on its stock price.
Financing - In a rising rate environment, this is going to be expensive. As far as I can see, S does not have any debt today. If it is there, it is very small. Taking on a loan could buy them time until they become cashflow positive, however it will increase operating expenses and operating cashflow needs.
They could raise funds via a secondary equity offering, however that will lead to more shareholder dilution.
Here’s the bottomline:
S has options, but none of them are pretty. Each of them come with pros and cons, and all of them could hurt us investors.
As we invest in Sentinel One, we should do so with an understanding of the broader implications of their negatively trending cashflows.
I am long both CRWD and S.