The cybersecurity market can be particularly brutal. Cutting-edge technology often doesn't last long, as the bad guys are constantly working on their own ways to undermine defenses and make off with valuable digital assets. Add to the mix that successful security companies are highly profitable and draw lots of competition, and it all totals up to a niche of the IT sector that's particularly tough for small start-ups to gain a foothold.
If that weren't enough, now also factor in impatient shareholders. This is apparently exactly the situation SentinelOne (S 1.70%) may be facing, as rumors have surfaced that the fast-growing endpoint security business (cyber software for laptops, smartphones, and other network-connected devices) was reportedly up for sale.
Things have been tough for SentinelOne, but why would management throw in the towel now? And what should investors do if they own some of the stock?
Not just an issue with business execution
Don't jump to the conclusion that SentinelOne's management team -- including CEO and co-founder Tomer Weingarten -- is trying to quiet quit after a terrible run following the initial public offering over the summer of 2021. The stock price is down over 60% from where shares debuted in public trading.
Also don't assume that a far-less-than-perfect fiscal first-quarter 2024 financial update is to blame. As a reminder, SentinelOne reported a 70% year-over-year increase in revenue last quarter, which ended April 30, but its outlook for full-year fiscal 2024 implies a sharp slowdown, and the company is still losing money.
For investors who still like SentinelOne's odds long-term, the real reason the cybersecurity outfit might be looking for a buyer could be far more frustrating than either of the two reasons above. The company has a dual share class -- consisting of Class A shares, which are publicly traded, and Class B shares, which are not. Class B shares hold the vast majority of voting rights for SentinelOne, which leaves the two venture capital firms that own most of those B shares, Insight Partners and Redpoint Ventures, with 48% and 23% of total voting power, respectively.
In other words, the vast majority of shareholders are effectively helpless to stop anything Insight Partners and Redpoint Ventures want to do with SentinelOne.
Your goals are not the same as venture capital goals
If SentinelOne was, or is, actively looking for a buyer, my hunch is it's because these two venture capitalists want to cash out and move on to invest in new, smaller ventures. Because that's what venture capitalists do.
If you're a long-term investor looking for high-quality businesses with great potential, your goals are most likely not aligned with Insight Partners and Redpoint Ventures.
But why would they want to sell now? Well, it appears that after a couple of years of more than 100% revenue growth, SentinelOne is settling into a more pedestrian growth rate that lines up with growth at cybersecurity competitors like CrowdStrike. The downside to this is that, as mentioned before, SentinelOne is still far from profitability, which means its stock may have limited upside potential until this situation changes.
Data by YCharts.
If you're a venture capitalist looking for the next explosive growth opportunity, SentinelOne isn't exactly cutting it for you anymore.
What to do if you're a shareholder
It's worth noting that the same rumors that claimed SentinelOne was up for sale also cited sources saying the offer price from potential buyers wasn't all that great. So, maybe SentinelOne continues on with its current ownership, and investors won't get cashed out early.
Nevertheless, this cybersecurity company's ownership structure is a risk to bear in mind for long-term-focused shareholders. Given this information, you might decide there are better cybersecurity stocks available to purchase, that have big shareholders that better align with your own interests. After just a few months with a small handful of shares, I'm considering an early exit from SentinelOne myself.
