SentinelOne – 'S' for success or 'S' for struggles?

[wsm007]

@mooo

with shares up by 20% and up 70% during the past 6 months.

With $1.1 billion in cash and no debt, SentinelOne stands on a solid financial foundation. I’ll continue monitoring the customer additions.

I’m relieved that holding onto S, as discussed in my June summary, has proven to be a wise decision. It’s great to see things turning out positively after years of suffering in a complex market environment.

First I want to say congrats and I want to say I’m happy that you made some money on the recent uptick. However, SentinelOne has been a terrible investment for me, and I made exactly the opposite decision to you after their Q1 results. I was furious, and I was of the opinion then that I left it way too late to exit. I.e. that I should have gotten out way earlier when Bear, Gaucho and others were making quite the convincing bearish case.

So your post had me wondering what the success you’ve described above is all about. Whether I’ve in fact missed something.

For me it was always a question of how S was doing vs competitors: relative outperformance. I switched from CRWD to S, and the core of why I preferred S over CRWD was that they were growing faster - both ARR and revenue, and they said they were taking significant market share. I thought this was a mini-CRWD successfully following the game-plan that CRWD laid. Problem is, they couldn’t grow fast enough while at the same time digging themselves out of the hole of unprofitability. And they were competing with CRWD. On top of that, S didn’t know how to calculate ARR and overstated that number which misled me. I was absolutely furious because that was a core part of my investment thesis.

Stock performance this year

The objective for me is always to own stocks that go up. And, if presented with the option of buying competitor A or competitor B in a space, that I make the right decision to achieve that. Fastly vs Cloudflare way back in 2020 comes to mind. So looking back, the question for me now is whether I should have continued my very successful investment in CRWD or whether I should have switched horses to S when I did. And I think the overwhelming answer of the past years is that owning CRWD has been a much, much better investment.

In fact you have to pick a very specific date to have S outperforming CRWD in the last year. I found two such dates: 3/6/2023 - just after S’s disastrous Q1 results, and in the last month - starting from 1 November. Starting 3 June 2023 S returned 88% vs 57% for CRWD. And starting 1 November 2023 S returned 54% vs 36% for CRWD. But that is market timing with a capital T.

In the last 3, 4, 10 months and YTD CRWD outperformed S.

	YTD move	Move from 1/3	Move from 1/6	Move from 1/9
S	65%	57%	16%	39%
CRWD	135%	102%	54%	50%

So how about last year?

In July 2022 I wrote a bullish piece on S, here’s me quoting myself (in order to teach me some humility):

@wsm007

And not to get into a debate on whether it’s warranted or not, but just to point out: S is trading at a revenue multiple of slightly less than CRWD, NET, ZS. So if multiples remain roughly where they are (I.e. the big re-rating is behind us), will outperform these names due to the superior revenue growth.

So how did those stocks do from 1/6/2022 to today?

CRWD: +50.2%
NET: +40.7%
ZS: +33.5%
S: -2.6%

→ S did the worst of the ones that I listed. S was the cheapest then and got way cheaper thereafter. In my defence I did say “if multiples remain roughly where they are (i.e. the big re-rating is behind us)” - which wasn’t exactly the case, and in addition S well and truly fumbled the ball.

And on a relative basis, starting in Sept last year vs a wider set of competitors, incl Palo Alto?

Source: ycharts

→ The worst of the lot.

So I dunno, but I don’t think S has been a good investment in the last two years or so, and I’m glad I exited when I did. And if I had held on, it would only have been a good decision when measured from quite a narrow number of starting dates. At least that’s my conclusion.

But that’s in the past. What about the current performance and the future?

Review of some metrics in the quarter

I haven’t looked at the numbers in 2 quarters, since the Q1 call in which the tone of management could not have been worse.

Alas, I again found some stuff that I really dislike:

This is their NRR graph from Q1 - note the dotted “target” line:

And this is from NRR Q2 - note the same dotted line, now without “target”:

→ That dotted line looks exactly the same in the two graphs, but the one now suddenly says “100%” after they dropped below that 120% target of theirs. Small, but irritating.

And while I take your point that many software companies saw NRR contract (not all, mind you @mooo - Axon actually increased their NRR, for example), I dislike how they describe it for us. Contrast the commentary of S with CRWD for the most recent quarter - both describing the same thing:

S: “Retention and expansion remained resilient across our customer base, reflecting an NRR of more than 115% in Q3.”

CRWD: “Our gross retention rate remained high and our dollar-based net retention rate was slightly below our benchmark in Q3”

Customers with >100k ARR

Everything to do with historical ARR irks me. They only restated ARR numbers going back to Q2 last year afaik and their customers with >100k ARR is only shown for the current and year ago quarters, meaning we now only have 6 numbers for this metric: Q1, Q2 and Q3 of this year and last. We don’t know how many >100k ARR customers they had in Q4 (or at least I couldn’t find it). Which means I can’t see how the additions in that metric has really trended over time.

On why this is so important, and for a great discussion about S back in December 2022, here is a post from Bear, again, in which he says that ARR added has stagnated at around/below $50m per quarter:

Relative to that discussion which focused on Net new ARR, what has the most recent numbers been?
2024 Q1: 41.6m
Q2: 48.6m
Q3: 51.8m

→ Less ARR added than Q4 FY 2022 (assuming that ARR added in Q4 2022 was actually $55m as they haven’t given us the full set of historical correct ARR numbers - back to my general irritation with their ARR numbers). In the link above Bear said in Dec 2022: “Seems like they’ve kind of stagnated the last 4 or 5 quarters.”. I think that can now read 8 or 9 quarters.

Market share

So, we only have a limited number of quarters for ARR added. Using those quarters, what has the ARR added been as a % of the total ARR which CRWD and S added in that quarter?

2023 Q3: 18.8%
2023 Q4: 21.0%
2024 Q1: 19.3%
2024 Q2: 19.9%
2024 Q3: 20.7%

Ok, so in the spirit of being generous I will say that they are “gaining market share”. But not much, and because the ARR numbers only go back so far, I really cannot guage whether this is true over a longer period of time. Vs the share of net new ARR of “the market” (narrowly defined for this purpose as them and CRWD) that they had to last quarter, they have gained an additional $2m of ARR which would have gone CRWD’s way. So if they had not increased their share from 19.9% to 20.7% they would have had $49.8 in stead of $51.8m of new ARR and CRWD would have had $200m in stead of $198m. Not sure that qualifies as strong market share gains.

Margins

These look very good. Gotta give them their due, and this is the main reason why I will continue to watch them.

Gross profit margin is up to 79% vs 71% a year ago and 77% a quarter ago. This has really stepped up. Three years ago this was only 58%. This really is great.

And the key one for me - operating margin - is now at -11% of revenue. Three years ago this was -102%. Again, really good progress.

But, SBC and dilution.

Their non-GAAP Op margin is -11% of revenue vs GAAP op margin of -50%, so 39% of revenue is SBC and some other funnies. And share dilution was ±5.7% based on the WA fully diluted share count. That’s a lot of dilution for a stock that’s been going down for the last couple years.

My own conclusion

Thanks for prodding me to look at S again - it brought back some memories
It’s also interesting to look at S vs CRWD from the point of view of market dominance. This is a great post by Saul about this, in which he said the following (I’m going to quote the whole thing as it’s part of the Knowledgebase I think, but it bears thinking through a bit more - he wrote this in 2018 and therefore came to his conclusion in May 2017):

@SaulR80683

About a year ago, in May last year, I realized that one of my criteria for investing was to pick companies that dominated their markets. I made up a list of categories, which follows below:

First there’s a Category Crusher, which completely dominates its space (Amazon is an example, in online retail).

Second would be a Category Leader, which puts this company in first place in its space, but where there are significant competitors.

Another category would be a Disruptor, a company trying to disrupt a stagnant market with new stuff.

New Market Stocks with respect especially to Big Data New Market Stocks. (Othalan suggested this addition and it’s a great suggestion).

Then there is a Rapidly Growing Company in a Rapidly Expanding (New) Market. It’s not dominant, and not necessarily the leader, but it’s growing rapidly because its market is growing rapidly.

Then there’s a Rapidly Growing Company in a Normal Market.

I think, upon reflection, S does not fit in any one of those categories, although I initially thought it was a Disruptor or a Rapidly growing company in a new market. In the end the “new” thing they did was not that new or disruptive as other, larger companies now offer the same or similar, and the rapid growth has really come to a bit of a stagnation, if not a halt.

I think, therefore, that I will wait this one out until at least another couple quarters. If I miss some upside, so be it. #zerofomo.

-wsm