The cybersecurity industry is so massive there won't be just one winner in the space. With multiple companies specializing in different aspects of protection, clients have to weave together a web of offerings to create a protection plan that can thwart the most adept attackers.
One of these companies is SentinelOne (S 1.70%), which specializes in endpoint security. This product keeps network access points like a laptop or phone safe from exploitation or malware. While this solution is required for nearly all businesses, is SentinelOne worth an investment? Let's find out.
A familiar product in a crowded space
Along with endpoint protection, SentinelOne also has an endpoint detection and response product, which protects the rest of the network should a single device become compromised. It also has security for Internet of Things (IoT) devices and cloud workload protection.
To protect these various segments, SentinelOne uses a data lake, allowing the software to know what is normal use and what constitutes a threat. With this information, it can create a top-notch cybersecurity solution for its clients.
If that offering sounds familiar to cybersecurity investors, that's because CrowdStrike (CRWD 2.03%) and Microsoft use this same endpoint protection method. These companies are also significantly larger than SentinelOne.
Furthermore, third-party research and consulting firm Gartner rated Microsoft and CrowdStrike as the neck and neck leaders of its Magic Quadrant for endpoint protection, with SentinelOne trailing both in the ability-to-execute rankings.
So, is the third-place company in this industry worth investing in?
SentinelOne's bottom line has a long way to go
If SentinelOne can show it's growing faster than its primary competitors (which it should given its size), then it's worth a look. However, comparing it directly to Microsoft isn't possible, since the tech giant doesn't break out its cybersecurity business.
In the fiscal 2024 first quarter (ended April 30), SentinelOne's revenue increased 70% year over year with annual recurring revenue (ARR) rising 75% to $564 million. Compared to CrowdStrike's first-quarter revenue growth of 42% and ARR increase of 42% to $2.73 billion, it passes the growth test.
It also brings up an interesting point: Despite SentinelOne sporting a market cap less than one-eighth the size of CrowdStrike, it boasts one-fifth of its rival's ARR. This shows SentinelOne could be trading at a discount to CrowdStrike, at least by this measure.
But when you take into account SentinelOne's profit margins, red flags immediately go up. At every level, they trail CrowdStrike's. In their most recent quarters, SentinelOne and CrowdStrike reported non-GAAP gross margins of 75% and 78% respectively. While that gap may appear small, a move down the income statement paints a clearer picture. While CrowdStrike expects to deliver a non-GAAP operating margin of 17% (at the midpoint of its range) in fiscal 2024, SentinelOne is guiding for a negative margin of 27%.
Both companies are reporting high levels of stock-based compensation, but SentinelOne paid out $56 million in the fiscal first quarter, or about 42% of revenue. Compare that to CrowdStrike's $131 million (19% of revenue), and the difference becomes clear.
The market for endpoint security is large, but it isn't unlimited. With SentinelOne at a significant size disadvantage, it makes me question if there is enough runway for it to eventually break even given the intense competition in the space. Even CrowdStrike only just reported a GAAP profit for the first time in its history.
To make matters worse, SentinelOne's full-year outlook indicates revenue growth will slow significantly in fiscal 2024. That slowing momentum and weaker margin profile likely explain its relative discount to CrowdStrike on a price-to-sales basis.
Data by YCharts.
While purchasing an underdog, second-tier business can work as an investment strategy, it requires much more due diligence and research than just buying the industry leaders.
Until SentinelOne proves its margins can improve to the point where the stock becomes a viable investment, I'm focusing on CrowdStrike.
