SentinelOne has to focus on cashflow improvement in 2023. They have no choice

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…

Assuming:

  1. No headcount change
  2. No acquisitions
  3. 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.

    1. Q2 balance sheet showed $269M in cash + $950M in short term investments
    1. 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.

Beachman

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In the current rising interest rate environment, I think it might be a wise way to deploy some of the short term cash into long term investments to get higher return. Just normal capital allocation.

If S is on track to be FCF breakeven by end of next FY, I don’t think there is any risk to move 455m short term investments into long term.

But FCF is definitely one of the key metrics to monitor moving forward.

Zoro

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I think the OP is sounding a couple false alarms.

First, moving cash from short term investments to long term investments does NOT make that money off limits if needed. It just means they’d lose some of the benefit of the move in the first place. It’s still their cash.

Secondly, hiring more bodies doesn’t equate to reducing cash flow from current rates, given that revenue is rising quickly. That will only happen if the outflows grow faster than inflows, which the CFO was pretty clear is NOT the plan.

15 Likes

BeachMan–
Your analysis shows several flaws. Let me try to summarize them:

How do you know? Have you run a projection model that shows this? If so, what are the assumptions of such projection model? I think in order to claim this, you have to show your work, and from the screenshots that you uploaded there’s nothing that even slightly resembles a projection model with cash flow implications.

Your claim that the company needs $60m of operating cash each quarter has no foundation and sounds more like a “liquidation value scenario”, which I guess is out of the question for a company still growing at triple digits and showing meaningful operating leverage. Also, what does “the average of operating and free cash flow numbers” mean? These are two different measures. I think that an analysis of cash burn should be done on free cash flow, not operating cash flow, as every company has maintenance capital expenditures that you cannot exclude from the picture. Finally, I would encourage you to split Selling expenses and G&A expenses, as these two categories are extremely different (and serve different purposes) for these types of companies. If, to grow their top line by 106% Y/Y, the company increases their headcount by 75%, I’m not particularly worried.

Long-term investments are called that in accounting terms because the company believes they will stay there for at least one year, NOT because they can’t be touched for at least one year. If you take a look at page 15 of Sentinel’s latest 10Q, you can clearly see that the portion that they deemed as “long-term” is made up of Treasury and Agency securities, Commercial paper, and Corporate bonds. So, nothing that cannot be sold with very short notice, if need be.

In the same 10Q, on pages 17 and 18, you can see that the total consideration for the Attivo acquisition was $535m (not $617m), of which $349m have been paid in cash (not $218m) and the remainder by issuing approximately 6m shares (not 100m!). For a company that has about 282m of shares outstanding, a 100m share acquisition would have been a little too much, more like a “merger of equals”. This is not te case here.

I’m sorry to point out these discrepancies but we have to be accurate with numbers.

In conclusion, I don’t think Sentinel is at risk of running out of cash, based on what I see today – even though anything might happen, but this is a different story.

Silvio

73 Likes