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My $S trades
While I have expressed some concerns about the long term durability of growth in the pure play cyber security sector, the near term demand is undeniable. I decided to open a starter position in SentinelOne (S) to get some exposure for my portfolio. While the top security providers all turned in strong quarterly reports in this latest cycle (CRWD, ZS, PANW), I prefer SentinelOne for the following reasons. This isn't necessarily a knock on the other companies - just splitting hairs here.
- S is still a <$10B company with just over $400M revenue run rate. The smaller size implies S has more runway before having to deal with the law of large numbers.
- High growth. With total revenue and estimated organic revenue both increasing over 100% y/y, S is growing faster than peers (albeit at a smaller run rate). Full year guidance was raised to 103% from 98% previously.
- Increasing Net Retention Rate (NRR). This is probably the most significant indicator to me. SentinelOne's NRR increased from 131% to 137% from Q1 to Q2, and was 129% a year ago. This demonstrates that their expand motion with existing customers is very strong, which helps maintain growth and drives operating leverage as sales efficiency goes up. Normally, as a company expands, NRR goes down.
- Net expansion isn't the only story. Customer additions hit a new record (even on an organic basis), with total customers reaching 8,600 and growing by 60% y/y. Customers with ARR over $100k increased by 117%. They closed their largest new customer contract ever in the quarter.
- Improving operating leverage. While still solidly unprofitable, the company is making significant progress. On a Non-GAAP basis, gross margin increased by 1000 bps y/y from 62% to 72%. Operating margin increased from -98% to -57%. Non-GAAP operating expenses increased by 85% y/y, versus overall revenue growth of 124%.
- From a product point of view, I like their emphasis on high scale, efficient data processing. They have already absorbed the Scalyr acquisition and integrated that into the core platform. Now all customers and products benefit from Scalyr's abiliy to ingest massive amounts of machine and application data in real time.
- SentinelOne works well with the partner channel and are driving a lot of growth from managed service providers. They have built an extensive and diverse network of channel partners, including MSSPs, MDR providers and IR firms.
While the valuation is high at about 25 P/S, it is inline with other security peers. Arguably, those are more profitable, but are growing at a slower rate. The high revenue growth of SentinelOne should bring down the valuation multiple quickly, allowing price to continue to increase. I plan to publish a longer analysis and may bump my allocation over time. I remain heavily weighted to other software infrastructure providers that have security exposure, but also address other market segments outside of security.
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