Is Okta Stock a buy after a price drop of more than 25%? (NASDAQ:OKTA)

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Thesis

Okta (NASDAQ:NASDAQ: OKTA) is a leader in the lucrative cybersecurity industry, but multiple execution issues have plagued the company lately. At this point, Okta is a risky bet that will only pay off if management can improve the quality of the business.

Introduction

I have been an Okta bull for a long time. I named it one of my top 10 stock picks for 2022 and also recommended the stock to members of Tech Investing Edge, my community of private investors. It’s been a tough ride, down 71% year-to-date, though it’s somewhat consoling that my other cybersecurity top pick CrowdStrike (CRWD) easily outperforms the S&P 500 year-to-date. the year.

In this article, I am revising my Okta thesis to hold due to a very high uncertainty rating on the stock. I think Okta has the most upsides, but also the most downsides, of the best cybersecurity companies. If Okta can improve its execution, then it’s one of the most undervalued stocks in the market today. But if not, there is no path to profitability or future alpha generation.

Cybersecurity Leaders Comparison

Let’s first look at the differences between Okta and its peers to better understand what I mean by runtime and quality issues.

finance

Teleprinter TTM turnover Rev. Growth Rule of 40 Gross margin R&D S&M P/S
OKTA 1.5B 43% -12 72% 36% 61% 6
CRWD 1.6B 61% 51 74% 26% 42% 23
SZ 1.0B 63% 35 77% 27% 67% 21

Source: Financial Statements

By comparing the three cloud cybersecurity leaders, it becomes clear why Okta is the ugly duckling. It has slower revenue growth and a terrible rule score of 40 and therefore deserves a lower multiple. No argument from me there. The key question is how much lower Okta’s multiple needs to be for it to be a worthwhile investment.

Structurally, there’s no reason Okta shouldn’t become as high-end as CrowdStrike or Zscaler (ZS). All of Okta, CrowdStrike, and Zscaler have gross margins between 72-77%. Like its peers, Okta is a lightweight software company whose primary expense is its employees. The main difference is that Okta has much higher R&D and S&M spending than its peers. Compared to CrowdStrike, Okta loses 29 points on the rule of 40 due to these expenses.

While Okta is likely several quarters away from a turnaround – if there is one – the good news is that it is not in immediate danger of bankruptcy. Their nearly $2.5 billion in cash and short-term investments should fund their losses for at least a few more years, even if they don’t improve in terms of profitability. Thus, investors have time to wait for a turnaround if they choose to stick with Okta.

Competition

A key question for Okta’s thesis is whether these operating expenses can and will decline, without negatively impacting revenue growth. Considering that gross margins aren’t the issue, the other main consideration is whether Okta faces too much competition and therefore needs those high operating expenses to fund its growth.

magic quadrants of cybersecurity

Gartner

As stated, Okta, CrowdStrike, and Zscaler are all leaders in their respective magic quadrants, with Microsoft being the only listed competitor ahead of Okta and CrowdStrike, and no one ahead of Zscaler. In fact, the identity and access management landscape looks a lot less crowded compared to CrowdStrike’s endpoint protection platform sub-sector; Okta actually appears twice in the leader’s corner of his magic quadrant thanks to his acquisition of Auth0.

Personally, I use Okta every day in my daily work and it works great. Instant login to all my work apps saves a lot of time and is more secure than alternatives. In my experience, Okta is a quiet and reliable service; it never logged out or stopped me from doing my job. The same cannot be said for the alternatives I have used, even those developed in-house by a much larger company.

I would actually say that in theory, Okta has a wider moat than other cybersecurity leaders. If I want to create a new endpoint protection platform, I build it and I can sell it almost immediately to customers. On the other hand, if I want to build an identity management platform, I first have to convince thousands of leading software products to integrate with me, and only then do the customers will be interested in purchasing my product. Of course, other areas of cybersecurity benefit from network effects, but I believe they are strongest in identity management.

So, as far as I know, competition is no more an issue for Okta than it is for its peers. This is another data point that allows Okta to finally get on the right track.

Evaluation

A key element of valuation is profitability. If Okta isn’t spending too much to fend off the competition, why is it so much less profitable than its peers? Well, I’m scratching my head about this one too, and a key part of my thesis is that those expenses eventually go down. Fortunately, this quarter, Okta’s expenses were lower than expected due to slowing workforce growth and strong revenue growth.

The other key element is growth. Although Okta’s growth is lower than CrowdStrike and Zscaler, I expect the gap to narrow in the future as I don’t believe >60% growth is sustainable for peers. ‘Okay in the long run. Meanwhile, there are signs that Okta’s growth could be held above 30% for some time. This is what management guided before this quarter. The current growth of 43% was supported by a 26% growth in the number of customers and a 35% growth in the number of large customers. Along with a net retention rate of 122% based on the dollar, this level of growth positions Okta well for years of strong performance.

What does this mean for Okta’s valuation? In the model I shared with members of Tech Investing Edge, if Okta can sustain 28% revenue growth and eventually achieve a 15% profit margin, I believe its fair value is $133. That’s well below my fair value estimate at the start of the year, but still more than double its current price of $65. On the other hand, I think CrowdStrike and Zscaler are close to fair value today. This makes Okta the most bullish option, assuming it can meet my growth and profitability goals.

Understand the reaction

Okta shares sold over 35% after earnings. On the face of it, there wasn’t much to worry about as Okta posted 5% revenue and 67% EPS, continuing a long streak of ups and downs. They also slightly raised the revenue and profit forecasts for the full year.

Based on these numbers, management could probably have considered these results to be strong and in line with expectations. Instead, CEO Todd McKinnon opened the call with a mixed message:

While the identity market opportunity remains healthy, our second quarter financial results were mixed. We delivered better-than-expected profitability, but our top line was not where we wanted due to challenges integrating the Auth0 and Okta sales organizations, as well as modest macro headwinds.

Despite the mixed messages, management once again reaffirmed that the security incident that occurred earlier in the year did not have a significant impact on Okta’s business; this incident nevertheless strongly contributed to the recent fall of the Okta share. They also said macro issues were showing up a bit, but didn’t seem to be as big an issue for Okta as for less defensive companies.

The main issue that management focused on was the acquisition of Auth0, which happened last year. In particular, they pointed to customer confusion and increased attrition following the acquisition, for which CEO Todd McKinnon took responsibility. For example, their sales team didn’t know which of the combined company’s two SIEM products to sell. Okta has taken steps to address this issue by drawing clearer boundaries between products.

Due to the impact of these issues, management noted that:

We are reducing our calculated billing outlook for the year by approximately $140 million due to the unfavorable outlook described above. We now expect calculated billings for FY23 to be approximately $2.04 billion to $2.05 billion, representing growth of 27% on a like-for-like basis or 19% on an as-is basis. than published. Given our short-term outlook coupled with the uncertainties of the evolving macroeconomic environment, we are currently reassessing our FY26 targets.

Following their report, analysts on the call were very harsh on management, questioning whether the Okta platform was secure in light of recent hacks and wondering if Okta was changing its strategy too much from what had was originally announced after the acquisition of Auth0.

Okta’s declining billing outlook raises the question of whether its long-term forecast for sustained growth above 30% is still achievable. Okta has acknowledged this and plans to update this guidance next quarter. That leaves us three months in the dark about Okta’s long-term plan, and we all know markets hate uncertainty.

It is very possible that Okta will return next quarter with a slightly revised forecast of, say, 25% or more of sustained growth, and that the stock will rebound strongly once clarity on the long-term model becomes available again. . Based on my price target, Okta has room to lower its growth forecast and still be undervalued today.

However, it’s also possible that things are worse than they appear, perhaps due to recent security incidents involving Okta, and that management is simply dragging their feet announcing much worse directions. Only time will tell.

Conclusion

Okta has a great product in a lucrative industry, but the business metrics haven’t looked so good. This is due to a combination of factors, including management’s preference for aggressive operating expenses, issues with the recent acquisition of Auth0, macro issues, and possibly recent breaches attributed to Okta.

If management can get things back on track, then Okta’s cheap valuation of 6 P/S gives it plenty of upside; far more than is available from fully-regarded peers. However, if things don’t improve after this year, investors might regret buying a fair business at a bargain price, instead of a great company at a fair price. Personally, I prefer owning big cybersecurity companies, and I don’t think Okta is one of them at this point.

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