WSM's September 2022 portfolio review

Wow the macro craziness certainly continued this month - still a helluva lot of uncertainty in the air. Especially from where I’m sitting in Northern Europe. This morning I saw another “UA” number plate at my local grocer, and I live in a small town more than 2000km from Ukraine.

A couple weeks ago I went for my umteenth COVID shot from a big temporary location outside the city and I saw queues of people - all getting out of “UA” cars at 9am in the morning. The big work-stream for local government was Ukraine refugees, not COVID anymore, and this was before the annexations of the last couple of days. And then we have an Etonian, son of Ghanaian immigrants to the UK, who studied history at Cambridge and Harvard, and managed to sink the pound and get the IMF to criticise his plans within weeks of becoming the Chancellor of the Exchequer, possibly dooming the brand-spanking new government in Downing street. Not to mention the new far-right and potentially fiscally irresponsible government in Italy. Oh and the US Fed raised rates by another 0.75%pts - the fastest pace of rate increases on record. It forced the Bank of Japan to step in to support the Yen for the first time since 1998 after the Yen lost more than 20% of its value against the dollar just this year. Globally the number of central banks raising interest rates in a month has not been this high in the last 50 years.

And that was just September…

A thought about cash as a portfolio position

Had I decided, back in May last year to play it “safe” and keep my money in cash, and for me cash means Euros, I would have lost just over 24% of my money in $ terms, before inflation. And inflation is a beast in Europe. In the Netherlands inflation was 7.6% in January of this year and is projected to hit 17.1% in September by Eurostat. That’s a lot of value lost. And I could have lived in Japan…or the UK. As it turned out I did not play it safe and I lost 32% in $ terms over that same period invested in high-growth “risky” stocks. And to be fair the massive losses of this year still hurt. But only because I keep anchoring on the ATH, which is folly, but I still do it.

Anyhow, enough of that. I just wanted to make the point that macro forces are impossible to predict imho and they hit every asset class - nothing is “risk free”. “Risk-free” government bonds lost a ton of value in many countries recently…

2022 YTD RESULTS PER MONTH

Jan -27.1%
Feb -23.9%
Mar -33.8%
Apr -43.4%
May -59.0%
Jun -59.6%
Jul -58.4%
Aug -54.2%
Sep -59.7%

Position sizes and why
Below are my current portfolio weightings, as well as what they were last month in brackets:

Cloudflare (NET)     18.0% (19.5%)
SentinelOne (S)      17.6% (15.0%)
Snowflake (SNOW)     13.8% (12.3%)
Bill.com (BILL)      13.2% (14.8%)
Datadog (DDOG)       12.6% (15.2%)
Gitlab (GTLB)        9.6% (6.4%)
Crowdstrike (CRWD)   9.8% (16.3%)
Twilio (TWLO)        0.9%
Cash                 5.0% (0.5%)

This month I will try to explain (also to myself :wink:) why I take the relative position sizes that I do within my universe of companies. It is not only a matter of confidence for me. I have confidence in all of the companies in my portfolio. But in my life I’ve made a lot of good and bad investments, both on the stock market and in private companies. And in all of the cases where I’ve done really, really well, I was able to get in relatively early on in the lifecycle of the company. I therefore tend to have larger positions in the smaller companies out there in terms of both revenue and market cap. That has of course been a disaster in the last many months, as the fastest-growing, smaller companies who were not yet cash flow positive (MNDY, S, NET) got crushed. The more mature and already CF positive companies that we follow also got crushed by any objective interpretation of that term, but by a lot less than the others (DDOG, CRWD, SNOW). Then we have the ones that stumbled - and got murdered (TWLO, OKTA) and the ones that stumbled and then fell (UPST, PTON) - who just got obliterated.

While I have no interest in that last bucket (the ones who fell), I feel all of the others are fair game, and I think that the tide will eventually turn. And right now the smaller, faster growing, not-yet CF positive companies are really on sale. So in stead of playing it safe (relatively, of course) and overweighting DDOG, CRWD, I’m overweighting - relatively speaking the likes of S, NET, BILL.

What I did in September

Not much, to be honest. Except a lot of hand wringing. I tried some trading but have now come to the conclusion that I am not, and will probably never be, a trader. My companies all reported in August and early September and the reports were roughly as I expected, except for MongoDB, which was worse and I sold after results and SNOW which was better and I increased my allocation. ZScaler was much better than I predicted, and I didn’t own it going into results. Still, I was not tempted enough by the big billings number to get back in. I keep on asking myself whether I would rather own NET, ZS or both. And my answer on that one keeps on being NET. So I mostly rebalanced to what I have now, and not much else.

SOME THOUGHTS ABOUT MY PORTFOLIO COMPANIES

In a recent podcast about Crowdstrike (‎Business Breakdowns: CrowdStrike: Cyber SaaS op Apple Podcasts) the analyst pointed out that CRWD was one of only two SaaS companies in history to have hit $2bn in run-rate ARR and still be growing north of 50% yoy - the other being Snowflake (and I believe the third will be Datadog). That took a while for me to digest. Were these three companies really that unique? I then looked for any company that hit $2bn in revenue except for Crowdstrike and Snowflake and was still growing >50%. I could find only a couple: Microsoft, Google, Facebook - and the first two are currently $1trn+ market cap monsters and the third until recently was (challenge to the rest of you guru’s: are there others?). That put these three companies of ours in a very, very select group and qualified them as the gold standard for my purposes.

Based on that, I set out to evaluate my other holdings against these three to see if I just maybe had a baby SNOW somewhere. Here’s what I did. I plotted these three’s revenues and operating margins from the quarter in which they had ±$45m in revenue (their last <$50m revenue quarter) up to the point where all three of them were operating margin positive, to see what that looked like. Here it is:


Now this progression of 11 quarters is telling in its own right: there is a very clear inverse relationship between operating margin and revenue growth. SNOW chose to spend much more than the other two earlier on, and grew much faster as a result. Now obviously there were other factors at play too, but these three are the gold standard; all 3 had fantastic product market fit, and crucially all had very high gross margins so I’m willing to ascribe most of the growth delta to their choice of burn rate. Happy to hear other arguments, but big picture, this is what I keep on getting back to (my own company is a case in point: we are profitable, nicely cash-generative, and grow at around 20-30% pa. Could we have grown faster? Hell yeah - if we had hired more people.) Even though DDOG had a positive operating margin when it had revenues of ±$45m and SNOW had an operating margin of -174% (gasp!!!) at the same time, 11 quarters later SNOW was sitting on a 3% operating margin and DDOG on 10%. Not such a big difference. But SNOW’s revenue was almost twice as large as DDOGs by that time, at $334m vs DDOG’s $178m.

Why all the ancient history? I think all 3 companies are exceptional. Truly exceptional - and I would have loved to have bought shares in all three when they had <$50m in revenues.

So knowing what their path looked like when they were smaller could perhaps help me evaluate whether I had the next DDOG, SNOW or CRWD in my portfolio.

So here goes.

SentinelOne

I’ve given a detailed write-up on the adjusted numbers (here: https://discussion.fool.com/wsm8217s-portfolio-1-july-2022-35139370.aspx) and the most recent quarter (here: https://discussion.fool.com/wsm8217s-portfolio-30-aug-2022-35160798.aspx). I can also really recommend @SlowAndFast overview of the numbers, and @stocknovice’s overview of the operational progress (also of all of the other companies in my portfolio for that matter). In addition to that, this is how S compared with the three greats above:

Revenue $m per Q, starting from ±$45m-3

See it sneaking in just above Crowdstrike and just below Snowflake on that revenue graph, and just above (i.e. better than) Snowflake on the op margin one? It’s tracking well to be another great company, if the incredible pace of revenue growth continues and operating margin continues to kick in. And management has told us that they aim to improve operating margins by 30%pts per year going forward, and improved it by 42%pts vs a year ago this last quarter. If they delivered on the 30%pts promise, they will be at operating margin positive territory in a quarter or two more time than Snowflake took to achieve the same feat. So yes, not quite as efficient a machine as Crowdstrike or Snowflake was when they grew up, but right up there with the best of them if they can continue to pull it off.

I think SentinelOne could just be the new SNOW, DDOG or CRWD in the making. And while S is now a $7.5bn market cap company, SNOW is $54bn, CRWD is $38bn and DDOG is $28bn. That’s roughly between 4x and 7x upside in a couple of years if they can continue on their path. And that is at current market prices, which I think are very depressed so there may be even more there if the macro gods decided to smile on us again.

Cloudflare

Cloudflare had a fantastic quarter followed by a jaw-dropping GA and birthday week. It has a market cap of approx $18bn.

For a great expert overview over the incredible innovation cadence, read Peter’s piece here: https://softwarestackinvesting.com/cloudflare-ga-week-recap/#more-6406

For Cloudflare the comparison I referenced above is a little less relevant as they had a number of quarters after the equivalent period.

We know NET is no SNOW in terms of the explosiveness of the growth. So what makes it such a great company? Its ability to continue to do more of the same quarter after quarter. There is a deceleration of growth visible for most of the companies in my portfolio, and Bessemer Ventures has calculated a growth decay of about 20% of the growth rate each year for their SaaS universe. But there has to date been no slowdown in Cloudflare’s revenue growth.

This is amazing, and is the story of their uniqueness. They innovate their way to maintaining hypergrowth.

In addition the CEO has said multiple times that they will be cash-flow positive in the back half of this year. And Prince is someone whom I believe when he says something like that.

Bill.com

I was a relative latecomer to the Bill.com party but have since made it a core holding. It has a market cap of ±$14bn and has been growing like weeds. There has been no metric that I can find fault with, and they seem to have integrated their acquisitions to perfection, resulting in a stratospheric growth rate. They have done all of that while keeping their operating margin hovering close to zero. Importantly they indicated that they plan to become non-GAAP profitable in 2023 - next fiscal year. Not operating margin profitable, no - bottom line profitable, excluding SBC.

Snowflake

Snowflake just came along and blew my socks off with their latest results. They grew at 83% yoy at a $2bn+ ARR run-rate, and they’ve been operating margin positive for the last 4 quarters and FCF positive for the last 7. It is clearly the #1 of the three “gold-standard” companies I highlighted above, and for being such a special company, I’m willing to have it as one of my largest allocations despite it having the largest market cap of the lot. The exception to my general story above of owning the smaller companies in larger proportion to the bigger ones.

Datadog

I don’t really understand why the dog is currently the closest to its 52 week low of all of my positions: only 9% above it’s low of 16 June. I thought the results were good but the leading indicators weren’t and pointed to a slowdown in the second half of the year. But I definitely didn’t think that it was that bad. Be that as it may, I like the current price and think that the team at the helm of DDOG is one of the best around. And although they certainly were cautious in their guide, the CEO commentary about new logo wins, attach rates and pipeline were all exceptionally positive. I wonder therefore, if we aren’t seeing something similar to what we saw with the onset of COVID, and that the run-rate will revert to historic levels after a quarter or so of slowdown. Regardless of which way it goes, I’m willing to sit on a slightly lower % allocation as we wait it out.

Gitlab

I’ve been thinking about my Gitlab position in the light of the various relatively negative commentaries by technical folks like @Smorgasbord1 and @FlixFool about the category, and their financial performance vs my other portfolio companies.

Gitlab has been a slower grower at this scale than DDOG, CRWD and SNOW was, but I think what got me excited is the recent acceleration in revenue growth coupled with the extreme bullishness on the conf call. It’s also a relatively smaller company at a $8bn market cap. They were a 50-60% grower last year and a 70%+ grower this year to date. And no other management that I listened to commented so strongly in this last quarterly results season that they have not seen any impact from macro in their business.

However the comments about the category and competitive dynamics do ring true, and additionally I’ve been pondering another nagging metric that I believe I may have too quickly rationalised away in my enthusiasm - $100k adds:

>$100k	Q1	Q2	Q3	Q4
2021		23	28	36
2022	41	59	44	65
2023	53	48		

They added 48 customers spending $100k or more in ARR this last Q, vs 59 a year ago and 53 last Q. That’s a slow-down however you want to cut it. Management did not address this, and no-one asked about it in the call. Also my initial rationalisation doesn’t sound all too convincing to me, the longer I thought about it. Basically, because they have such a high NRR and they target really large companies (T-Mobile size), I argued that a more interesting metric to look at is $1m ARR customers. And to be fair that did grow nicely: they had 39 of those end Jan 2022 vs 20 end Jan 2021 (+95%). But we don’t know what that metric did this q so no use postulating a large increase there.

So maybe that $100k customer adds is seasonal? What does $100 customer growth look like QoQ?

>QoQ%	Q1	Q2	Q3	Q4
2021		12%	13%	15%
2022	14%	18%	11%	15%
2023	11%	9%		

Nope, not a seasonal thing and also a slowdown - first time it dipped below 10%…So now I’m hanging my hope for a continuation of their recent >70% growth on to management’s commentary alone, and not on the numbers supporting same.

Wary of Saul’s commentary that sometimes we don’t see the forest for the trees, I’m still willing to give this one a go despite those concerns. But the commentary about their competitive position and the market for dev tools in general, coupled with this metric and the fact that their operating leverage, while present, is a much slower march to profitability than some others, led me to conclude that I was perhaps a bit too enthusiastic in my allocation and intend trimming this one down a bit.

Crowdstrike

Top dog in an industry with huge tailwinds. But after my initial write-up last month I started seeing more cracks in their results than for some of the others. Their revenue growth rate dipped below 10% qoq for the first time ever. If that sequential growth would persist they would be a sub-50% grower very soon.

And then there are the leading indicators. Even though they added a record net new ARR of $218m in the quarter, their RPO growth dropped to 49% yoy (vs 60% in the prior Q and 81% in the same q last year). cRPO was worse - it grew just 37% yoy last Q and current deferred revenue by 54%. And although this only reflects commitments, I like them apples more if they are committed than not.

Similar to DDOG, I feel more comfortable with a slightly lower position here until they show me that those customers who decided not to commit to longer contracts, did in fact end up spending the money.

Twilio

Twilio is a bottom-fishing experiment and a tiny position. I’ve never owned the company before but I’ve followed them closely as they are active in the field that I work. They are dominant in their field. Their stock has been beaten into the ground because of a spending habit which the CEO said he is now going to rehab for (but he just had to take a last swig of the spending bottle with the announcement of a “sabbatical program” for tenured employees this last Q). Let’s see if he sticks to the 12 steps in the next quarters. For those who don’t know the details: management said they will become profitable next year (they’ve never been), and took a first step by announcing the axing of 11% of the workforce. But it’s not yet clear that the market believes they will actually do what is necessary to get there. If they actually do produce the goods on that front, the stock could rerate nicely.

CLOSING

And that’s it, folks. This year is quite a slog…

Good luck to all!

-WSM

Previous reviews:

August 2022: https://discussion.fool.com/wsm8217s-portfolio-30-aug-2022-35160798.aspx

June 2022: https://discussion.fool.com/wsm8217s-portfolio-1-july-2022-35139370.aspx

May 2022: https://discussion.fool.com/wsm8217s-portfolio-30-may-2022-35121245.aspx

Apr 2022: https://discussion.fool.com/wsm39s-portfolio-review-april-2022-35102080.aspx

Mar 2022: https://discussion.fool.com/wsm8217s-portfolio-review-end-march-2022-35085614.aspx

Jan 2022:https://discussion.fool.com/wsm8217s-portfolio-31-jan-2022-35041176.aspx

Dec 2021 full-year: https://discussion.fool.com/wsm8217s-year-end-portfolio-dec-2022-35015067.aspx

Dec 2020 full-year: https://discussion.fool.com/Message.asp?mid=34710356

151 Likes

Wow, WSM, what a wonderfully thoughtful write-up. And I loved the way you used your graphs. I also see that we have the same top four positions (although in a different order. Mine are in the order SNOW, NET, BILL, and S). I also have Datadog and Crowdstrike as a bit smaller positions. I did keep an even smaller position in Monday, however, which I think qualifies as one of your extremely rapidly growing small cap SaaS companies, but with a little less confidence. I decided against Gitlab, but that doesn’t mean that it won’t do well.
Thanks again for your post,
Saul

49 Likes

WSM,

I always enjoying reading your updates, and I also like your analytical arguments. I often agree with them. Sometimes, though, we use the same data to arrive at different conclusions or decisions. I liked how you compared the charts of SNOW, CRWD, DDOG (and then S). The charts showing the revenue growth once quarterly revenue hits >$50M were interesting. They do illustrate that CRWD, SNOW, and DDOG are special companies, and those three are by far my largest positions. And when combine with operating margin these companies (CRWD and DDOG) have become self-sustaining. And SNOW is on a rapid path toward achieving its stated operating margin goal; you and I agree that SNOW is also a special company. If only we had a time machine and could invest in Google or MicroSoft when they were the size of SNOW. Well, SNOW is a large position for me, and I think if you took that time machine into the future, we’d probably see a trillion dollar company.

When you look at S on the revenue growth chart, it does appear that it’s on almost the same trajectory as SNOW. Even the chart showing the operating margin shows that S has caught up to SNOW (SNOW from six quarters ago that is). I can see your argument for owning S based on the the progress and projecting forward. The projecting forward part is where our conclusion/decisions differ. S is one of your largest holdings, and I don’t own any S. And I don’t want any S. I know my opinion differs from many growth investors who frequent Saul’s Board. Let me explain.

  1. I see little stopping SNOW from achieving hypergrowth for many years into the future. Management has stated this repeatedly and the evidence is pilling up that they will be correct. S, on the other hand, is operating in a much more competitive environment that could (and I argue probably will) crimp growth. S is still burning through a lot of cash so if the growth slows too much before S has greatly improved its operating margin then the company could fail to reach a state of self-sustainability where it no longer needs outside capital to fuel further growth. The market has fierce competition from the likes of CRWD, PANW, and MSFT all of which can outspend S on S&M, R&D, and M&A by many multiples. S’s fight for new business and development of new products and features are not something that S can scale back on if it wants to remain competitive. I think that today’s competition has raised the stakes in the cybersecurity market compared to when CRWD was rising up; by looking at the numbers, it appears to me that CRWD has managed to build its business for less than it’s costing S today.

  2. Financial strength is another risk for S. It’s related to my last point but a little different. When CRWD was where S is today, capital was very cheap (almost free) and share prices were much higher (equity raises were better and easier then). Back then it was possible for a company to easily raise a ton of cash to be in a position to take advantage of many opportunities like more customer acquisition or an acquisition. The environment to raise new money is very hard now and it’s much, much more expensive. For a company like, S that’s still plowing a ton of its cash into growth, it adds a big risk. S needs to be a lot more careful than CRWD needs to be. We don’t know how long money will be tight, but it’s feasible that it could be a couple of years. If S burns $500M a year on growth and acquisitions then it has less than three years of cash in a time when it’s unclear if it will be able to get more. CRWD need not worry about this because they can spend a lot on growth and acquisitions and still not burn any cash.

  3. There are strong cyber security tailwinds that are helping all of the strong competitors. These tailwinds will fade at some point and turn into tough comps. Will S be able to maintain growth and continue its march toward high operating margins when the tailwinds fade. With at least three strong competitors fighting for fewer dollars, it may be hard to control the cash burn and also still grow fast when the competitors are competing for fewer customer dollars.

I’d agree that the upside for S is probably better for S than alternative SaaS companies. That’s if growth continues on a high trajectory and if it continues to rapidly increase operating margins and if it doesn’t run out of money. I could be wrong and S could be one of the best SaaS investments but I tend to think that the risk of S hitting a wall on growth and on operating margin progress is too large to attract my investment dollars. Yes, I’ve become a bit more risk averse in this environment.

GauchoRico

86 Likes

Hi Chris,
We have to disagree on Sentinel. You seem to be focussed on all the things that could go wrong in three or four years (sure they ‘could’) but you seem to be totally ignoring the numbers that are telling you what is happening right now.

Last quarter, this company grew Annualized Recurring Revenue by 122% (more than doubling). Sure, a little of that came from Attiva, but 122%… (Crowdstrike grew it by 59%).

They grew revenue by 124% !!! And up 31% sequentially. The guide is for more than 100% growth yoy (which presumably they will keep raising). I don’t have ANY other companies guiding to over 100% growth. It’s hard to evaluate as they will be including Attivo from now on. All in all you can say that they will probably be reporting annual revenue growth probably over 110%, which is enormous, but organic growth about 95% or 100%, as a piece of revenue will be from the acquisition.

And you set up a strawman talking about them potentially losing $500 million a year and going broke. This quarter their operating loss was just under $60 million (they have $1.2 billion in cash, so that was a little less than 5% of their cash), and their operating margin improved by 40 points. In fact, here’s what their operating margins have been: -129%, -98%, -70%, -66%, -73%, -57%, so losses are continually coming down as a percent of revenue (they dropped 41 points this quarter yoy from -98% to -57% ).

And then there are gross margins which hit a record 72%, up from 62% a year ago, and from 68% last quarter (in case you were worried that they had to cut prices to compete).

And their NRR was a record 137% as well (up from 129% a year ago).

Total customers grew more than 60% yoy to over 8600 customers.

Customers over $100K grew 117% yoy to 755.

Cloud security is their new field and by the end of the Apr quarter had grown to 20% of their business from practically nothing a year ago. And remember that’s not growing to 20% of a legacy business that’s standing still. Endpoint security had been their main business, and they are adding one market after another (like Cloud Security and Identity, etc), but Endpoint is still growing like mad too, as is everything else. This company is growing incredibly fast.


Here’s a Q&A on their Cloud business:

Q - When you guys are running cloud security alongside an incumbent endpoint vendor, are you guys typically seeing opportunities to eventually displace that vendor later on, or is the focus on these accounts primarily on the cloud security opportunity?.
A - we’re definitely looking at this as kind of a backdoor to the account. It allows us to unlock many accounts that already went at some point in the past with another endpoint provider. It allows us to really go in on the merits of our cloud protection platform. And then people are always looking for ways to consolidate further. That opens the door for that endpoint conversation. But to be honest, these cloud opportunities are usually 4x, 5x, sometimes 10x the size of the endpoint opportunity. So we don’t really feel bad about going in deeper into cloud and we treat the ability to then expand over to the endpoint footprint as more opportunistic. But taking that into account, clearly it’s a way for us to continue to unlock more and more accounts, both on the cloud side, but also on the endpoint side.



They announced the launch of S Ventures, a $100 million fund to invest in startup companies with a focus on security and data companies that bring innovative use cases to the Singularity Marketplace, Sentinel’s open application ecosystem allowing security teams to extend Singularity XDR use cases.


And here’s how they describe their Mission
‘Cybersecurity is constantly changing. Time favors the adversary. Today’s challenges are nothing like tomorrow’s. Threats are becoming more and more advanced leveraging the power of automation. Some wait and react. At SentinelOne, we innovate. Our mission is to defeat every attack, every second, of every day. Our Singularity Platform instantly defends against cyberattacks – performing at a faster speed, greater scale, and higher accuracy than possible from any single human or even a crowd. [:grinning:]. So, if our tech seems like something from the future, good — that’s exactly what it is.’

“Cybersecurity is constantly changing. Time favors the adversary. Today’s challenges are nothing like tomorrow’s. Threats are becoming more and more advanced leveraging the power of automation. Some wait and react. At SentinelOne, we innovate. Our mission is to defeat every attack, every second, of every day. Our Singularity Platform instantly defends against cyberattacks – performing at a faster speed, greater scale, and higher accuracy than possible from any single human or even a crowd. [:grinning:]. So, if our tech seems like something from the future, good — that’s exactly what it is.”

Of course I could be way wrong and they could go broke, but it sure looks like they are hitting all the boxes that you’d expect out of a little company that is growing like mad and just hit $100 million a quarter for the first time.

Saul.

82 Likes

Saul,

I know that you and others have large positions in S. Perhaps this investment will do great. My opinion is that the risk in this type of environment is too great. A year ago the business and financing environment was so much more favorable. But I want to put some hard numbers to my concerns about S’s burn rate. Now, if you read my previous post carefully, you will see that I included the cash deployed for acquisitions. I think it’s highly likely that S will need to continue to make acquisitions in order to keep up with the innovation (including M&A) coming from CRWD and PANW (and MSFT too). So let’s look at two sets of number over the past year: cash burning in funding operations and cash expended for acquisitions. For this, I turn to the statement of cash flows. In the most recent statement (for Q2 FY2023), we see that during the first six months of the fiscal year S spent $281M of cash for acquisitions. The Attivo Networks acquisition was for $616.5M but this was a combination of cash and stock. On the same statement of cash flows we can see that S burned through $111.5M in cash from its operating activities. So, for the past six months we’re already at $393M of cash burned. Now, to get a full year of cash burn, we need to add the last two quarters (Q3 and Q4) of FY 2022. For that, I’ll look at the cash expended on the Q4 FY2022 statement and subtract the cash expended shown on the Q2 FY2022 statement. The Q4 statements shows CFFO at -$95.6M and cash used for acquisitions at -$3.4M for a total of -$99.0M. On the Q2 statement of cash flows we have -$72.8M and -$3.4M for CFFO and acquisitions, respectively. So the total for the last 2 Qs of FY 2022 was -$22.8M. So, for the past year, S burned $416M of its cash. So, is $500M a year from the next few years really a straw man? Perhaps, only if S doesn’t spend any more cash on acquisitions. But my argument is that S is very likely going to need to do more acquisitions in order to keep up with innovation in the field. Here’s an announcement from PANW from today:

https://www.paloaltonetworks.com/blog/2022/10/xsiam-to-revolutionize-the-soc/

Also, while the operating margin has been shrinking that number of cash expended from operations each year has been rising: -$44.4M in FY20, -$66.6M in FY21, and -$95.6M in FY22, and already -$111.5M during the first half of FY23. Ok, the cash balance is still $1.2B but it was almost $1.7B six months prior. Was the Attivo purchase necessary?

No, I don’t think S will go bust. But I think that they could get into trouble if they keep burning cash, and this could really hurt management’s choices. The company has grown too valuable and the way to save it in this scenario would be for S to get acquired by a larger company without cash worries or by a private equity firm.

Again, S’s competitive landscape is so different from SNOW’s. The cloud part of the cyber security market has attracted competition from PANW and MSFT (CRWD was already building out their business a year before S was founded). This environment will have a lot more challenges arising from competition than SNOW will have in its market. So going back to my reason for my original post in response to WSM’s post, you can’t just look at SNOW’s revenue growth and operating margin trajectory and assume that S will easily follow the same path. Of course, I realize that I may be missing a good investment by passing on S, but, as Warren Buffett said, in investing there are no called strikes.

GauchoRico

60 Likes

Well Gaucho, you make some very good points, and I was never saying Sentinel was better than Snowflake. (In fact, Snowflake is my largest position by a considerable amount actually.) I was just pointing out that Sentinel is a very small, very rapidly growing, SaaS company, and it is perfectly normal for one of them to put all its money into growing as fast as it can, because that revenue will come back, and larger, every year.
Saul

46 Likes

Gaucho, you bring up some good points. I was out of SentinelOne because I saw the same concerns and it appeared they were decelerating too fast. Then, this Q they grew ARR by ~19% organically and ~29% total – sequentially. Amazing. I know that we have to watch this company closely to make sure they keep up a torrid pace, but I think that goes for all of our companies. I think that SentinelOne is potentially a lot more of a peer to Crowdstrike than it sounds like you think they are. Which leads me to @wsm007’s quote above. SentinelOne is not Crowdstrike (or Snowflake etc) yet. But it’s also not valued like them. With SentinelOne at a mkt cap of just over 7b and Crowdstrike at ~37b, all we really have to believe is that the cybersecurity market is fragmented enough for both to win. Between these two, Palo Alto, Zscaler, Cloudflare, Fortinet, Microsoft, Okta, Trend Micro, Proofpoint, IBM, Splunk, and probably dozens of others, a “fragmented” cybersecurity market is the way I’ve always seen it. I don’t think there will be anything close to a “Datadog of cybersecurity” or a “Google of cybersecurity.” I think a lot of winners is just the way things will be. It seems like there’s plenty of growing spend to go around.

Maybe I’m wrong and a few of these will rise to the top in each category (Crowdstrike in endpoint perhaps) and choke out the rest. But wedontknowdis. And so I feel like SentinelOne is as legitimate and as good of a bet as anything, as long as we like what we see as we follow the growth numbers. I get your assertion about acquisitions, but that’s even harder to predict. Yes, if FCF loss keeps increasing in real dollars (doesn’t inflect) in a few quarters, I’ll probably reduce or get out. But right now they seem to be on a good path, and integrating the acquisition well.

So I think it’s at least possible that it’s not correct to see SentinelOne as a tiny player hoping to become viable. They will pass 500m in ARR this quarter, and sure Crowdstrike has over 2b, so SentinelOne is of course smaller, but it’s not exactly David and Goliath.

It’s not one of my largest positions because I think there’s a lot to watch. But when I compare this to every other company I know about under a $10b mkt cap, I think SentinelOne is the most worthy investment. Sure, I don’t have to have a company of that size at all! But importantly, I’m constantly reminded that I can’t know with any certainty how the future will play out, so I want to have a few more shots on goal – as opposed to having giant (15-20%) allocations in just a few companies, like I have in the past couple years.

Just my $0.02.

Bear

68 Likes

And in evaluating Bear’s willingness to take a position in Sentinel it’s important to realize that Bear is as cautious as they come. In fact, he’s the poster child for caution.:grinning:


In considering the below quote from Bear’s post:

“So I think it’s at least possible that it’s not correct to see SentinelOne as a tiny player hoping to become viable.

Think about the conference they just organized, where they got as keynote speakers, among others, Microsoft Azure’s CTO, Crowdstrike’s Cofounder and former CTO, the Director of the NSA (National Security Agency’s) Cyber Collaboration Center, and the first Director of Homeland Security’s CISA (Cyber Security and Infrastructure Security Agency) .

I tiny player hoping to become viable just can’t collect the top security people in the country like that, just CAN’T!

Best,

Saul

61 Likes

I’ve nothing to add with respect to the excellent financial analysis already provided, both pro and con. I previously held a position in S, but then sold it due largely to the same concerns Chris mentioned.

But, I’m now very tempted to at least dip a toe in the water due to WSM’s analysis combined with Saul’s comments, as well as additional observations based on my previous IT experience.

I was not in the IT security group, but I worked with them on a regular basis as there was a close relationship between my area of responsibility and theirs. The thing that I am reminded of relates to the competitive environment of cyber-security vendors. Our security folks used to always emphasize what they called layered protection. While they would seek best in class for a given vulnerability, they would never rely on a single vendor. They felt that heavy product concentration from a single vendor was a risk unto itself.

I have no way of knowing if this is current practice, or even if it was common practice when I was still working in IT. But it was the practice at Boeing about 12 years ago. At that time Boeing was under virtually constant cyber attack. Of course, 12 years ago was prior to SaaS and cloud migration. Nevertheless, I think it’s not unlikely that many companies would intentionally seek out different vendors for security products related to endpoint, cloud, identity, etc.

I think that even though there’s a lot of competition, there’s room for several vendors to succeed. In addition, I think that overall market penetration is still quite low. There are a lot more companies that have not yet made significant investments in cyber-security than there are companies that have comprehensive cyber defenses.

33 Likes

Great writeup WSM! Thank you! Regarding some of the arguments and criticisms of S (and on a larger more theoretical business level), it is fascinating to me that an argument can and is now being made that a company like S with $1.2 Billion (with a “B”) in cash is not enough to survive when their burn rate is less than 5% of that number and dropping. Sure its possible, but not likely. Its also possible Slootman at SNOW suddenly starts making a bunch of horrible decisions and decides he doesn’t care about growth or profitability or survival and drives the company into the ground, but I doubt it or I would not invest in them either. No doubt the markets have fallen on tough times…perhaps even worse now than the dot.com bust of 2000, but I’m certainly not yet convinced a "B"illion dollars in cash is “not enough” to reach cash flow positive and profitability; and I certainly have not seen any naive or flagrant moves on the part of management so far. I hear the argument about acquisitions, but a company would be foolish to go that route excessively and to the detriment of their own survival; any prudent management team simply would not. I’d also point out that S raised their cash in a very favorable environment and time, and now could purchase many of the companies that were at 70% higher prices when they raised their cash at tremendous discounts now compared to the time and cost they paid when acquiring Attiva, which also seems to be working out quite nicely for them. I’d also point out and argue that S made some excellent chess moves last year “when the getting was good” and are extremely well positioned to benefit from those moves now and in the future. Considering how prescient those moves now appear in hindsight and how well they positioned themselves, I have to at least give them the benefit of the doubt that they are not going to go off suddenly and make a few horrible moves that would jeopardize their survival, put their “King” in jeopardy and undermine their ability to survive and continue to grow at what no one can argue right now is not an extraordinary pace. I maintain about a 9% position in S and am looking forward to seeing how the next quarter and year pan out for both cyber-security and S. Granted, the competition in cyber-security is fierce, but the pie is also growing and S has proven its ability to capture their fair share. I shall give them the benefit of any doubt they will be able to continue to do so going forward and refrain from writing them off until they show me otherwise. Their numbers and last quarters results certainly speak for themselves. Cheers! -Poleeko

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