Investment Thesis
Okta (NASDAQ:OKTA) delivered a strong first quarter of fiscal 2025, exceeding expectations for both earnings and revenues. However, the market reaction was surprisingly negative, highlighting its tendency to overreact to news and its focus on potential concerns over positive results.
While Okta beat estimates on earnings, revenue, and raised its full-year guidance, the calculated remaining performance obligations (cRPO) for the next quarter came in below expectations, according to their last earnings call. This raised concern about a potential growth slowdown, overshadowing the positive financial performance. Additionally, the number of new customers was weaker than anticipated, further contributing to the market negative reaction.
But ultimately, when you look at the guidance not just for Q2, current RPO, but also any of the guidance that we gave here today, we are factoring into two main things, right? Macroeconomic headwinds are still out there. It's really affecting us in two different ways. One is on new logo acquisition. The other one is on the upsell side of the house around seed upsells, monthly active user upsells on the customer identity side.
The significant drop in stock price despite the overall positive financial performance highlights the market's focus on potential growth challenges and the volatility of Okta's stock. It's important to remember the stock market often overreacts to news, and big price drop can present opportunities to buy high-quality stock. In this article, I will discuss if Okta is a stock that I consider a growth at a reasonable price. For this reason, I will carefully analyze the company's fundamentals, technical factors, and its corporate strategy.
Okta's strong performance in subscription revenue, customer base growth, and raised guidance all point toward a company focused on sustainable growth. While not yet profitable, Okta's operating losses are narrowing, and I expect the company to achieve positive EPS in the long term. Despite challenges of the macro environment and the security incident from the end of last year, Okta's increasing financial strength, as evidence by rising free cash flow and low debt, coupled with its focus on key areas like security, innovation, and operational efficiency paint a positive outlook. Based on this analysis, I am inclined to initiate coverage on Okta with a Buy.
Management Evaluation
Todd McKinnon is the CEO and also the co-founder of Okta. He co-founded the company is 2009 and has led its transformation into a major player in the digital world, making identity a key security and business growth factor. Todd's experience spans over 25 years in enterprise software and cloud transformation. He led leadership roles at Salesforce (CRM) and PeopleSoft (ORCL) before funding Okta.
It's important to note that Okta announced layoffs of 7% of its workforce earlier this year, which may have impacted Todd's employee rating on Glassdoor. Additionally, as a co-founder, he holds significant voting power and financial stake in Okta and also receives around $300k in salary. According to the latest 10Q, Okta insiders control 40% of the voting power. Therefore, I find that he has "high alignment ratio" with the long-term success of the company.
Brett Tighe, Okta's CFO, oversees finance, accounting, and investor relations. He guides strategic investments in international expansion for long-term growth. Previously, Brett was Okta's Senior VP of FP&A and Treasury. He also held financial positions at Salesforce. Under Brett's leadership, Okta's company equity has shown a positive trend, and the company has grown organically, minimizing debt reliance and maintaining high solvency ratios.
Overall, I believe the Okta team demonstrates a strong commitment to the company's long-term success. With Todd at the helm and a high alignment ratio, the leadership team is well-positioned to navigate current challenges. While the company is still relatively young and facing a tough macro environment, it has a clear strategy in place to reignite revenue growth.
Based on these factors, I'm giving the Okta team a "Meets Expectations". However, it's important to monitor employee low morale, which is currently below the industry average as reflected on Glassdoor, particularly following recent layoffs. Addressing this concern will be important for long-term success.
Corporate Strategy
Okta's strategy centers on a cloud-based, user-friendly Identity and Access Management (IAM) platform with robust security features, targeting mid-sized to large enterprises. This contrasts with competitors like Microsoft Entra ID, which leverage its vast ecosystem and focuses on large to mega enterprises. Another competitor, CyberArk, dominates the PAM (Privileged Access Management) business, which is a more niche market and aims to protect highly sensitive accounts and credentials.
I have created the table below comparing Okta current strategy to some of it current competitors:
Okta Ping Identity (Private) Microsoft Entra ID (MSFT) CyberArk (CYBR) Corporate Strategy Focused on cloud based, user-friendly IAM platform with strong security features. Prioritizes innovation and growth Strong focus on security and compliance in IAM solutions. Targeting both enterprise and mid-market segment Leverage the vast reach of MSFT cloud infrastructure and integration with other MSFT products. Targeting enterprise customers. Focus on privileged access management and identity governance, offering a strong security posture. Market Share of IAM 5% 2% 15% N/A Advantages Strong brand recognition and user experience. Extensive integrations with other cloud platforms. Focus on security and compliance Deep expertise in security and access control. Broad range of IAM solutions for various needs. Scalable platform for large organizations. Deep integrations with MSFT ecosystem. Strong security posture and compliance features. Extensive scalability and support Leading plater in Privileged access management (PAM) - a segment where Okta does business. Strong security features and compliance capabilities. Deep expertise in identity governance. Disadvantages Relatively smaller market share compared to Microsoft. Recent security incident may have impacted brand perception. Can be complex to set up and manage. Less user-friendly interface compared to Okta. Can be less flexible than some competitors. May lock customers into MSFT ecosystem. Primarily focused on PAM not broader IAM. Can be complex to set up and manage.
Source: From companies' website, presentations, Seeking Alpha, Gartner Report
Valuation
Okta currently trades at around $88.74, dropping around 8% after it reported earnings.
Employing a conservative 11% discount rate (r). This represents a hurdle rate that an investor expects to receive considering time value and inherent risk of that investment. To calculate it, I used a 5% rate for time value in addition to a 6% average market premium.
Then, using a simple 10 year two staged DCF calculator and I reversed the formula to obtain its implied FCF growth rate which is around 19%.
$88.74 = sum^10 FCF (1 + "X") / 1+r) + TV FCF (1+g) / (1+r)
*I added Book Value in the calculation
That is, the market currently anticipates Okta's FCF to grow at 19% this year. However, FCF is expected to grow at a 117%, faster than industry average of 15%.
This FCF growth rate seems to be high and not sustainable over the long term so looking at the average 3 Year FCF growth I find that it's been growing at 47% growth:
Therefore, I believe Okta is undervalued at this point with the market only pricing a 19% growth in FCF. I also have confidence in the management ability to carry out its growth strategy and in its competitive advantage due to its corporate strategy.
Technical Analysis
Okta stock price is volatile with momentum slowing after the earnings report. The stock broke an important short-term support level at $92 to close the day at $88. I believe the stock might bounce back but due to its volatility, it might move around $81-$97 until more information becomes available. I will revisit my investment thesis as needed.
Next earnings report is estimated to be August 29th.
Takeaway
Okta strong Q1, exceeding expectations, was met with a surprising market sell-off. Concerns about growth and customer acquisition overshadowed positive results, highlighting market overreaction and Okta's volatility. However, robust subscription revenue, customer base growth, and raised guidance suggest a focus on sustainable growth. Narrowing losses and rising free cash flow point to profitability. The strong leadership team and clear growth strategy are encouraging. Despite volatility, I believe Okta offers a compelling growth opportunity at a reasonable price. For this reason, I am starting my coverage with a Buy rating.
Matteo Sada, CFA
Over 12 years of dynamic experience in the financial industry, I excel as a trader, portfolio manager, and equity research. As a CFA charter holder, I meticulously navigate the financial landscape, employing a comprehensive approach that blends top-down and bottom-up analysis. My investment philosophy centers on synthesizing Growth At a Reasonable Price (GARP) and value strategies, though I remain adaptable to market shifts. Completing an MBA has enriched my investment perspective incorporating corporate strategy standpoint. My extensive trading experience has honed my understanding of momentum factors which also influence my investment decisions. Follow me to stay tuned.
Analyst’s Disclosure: I/we have a beneficial long position in the shares of OKTA either through stock ownership, options, or other derivatives. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Rating systems don't consider time horizons or investment strategies. My articles aim to inform, not to make decisions.
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