TLDR
1. Downside seems limited to about 20% based on recent acquisitions
2. Upside is about 50% if growth re-accelerates
Business
Okta is not a business most people are familiar with. Here’s how they describe themselves –
Okta, Inc. (the “Company”) is the leading independent identity partner. The Company’s Workforce Identity Cloud and Customer Identity Cloud, powered by Auth0, enable customers to securely connect the right people to the right technologies and services at the right time. Employees and contractors sign into the Workforce Identity Cloud to seamlessly and securely access the applications they need to do their most important work. Organizations use the Company’s Identity Platform to collaborate with their partners, and to provide their customers with more modern and secure experiences in the cloud and via mobile devices. Developers leverage the Workforce Identity Cloud and Customer Identity Cloud to securely and efficiently embed identity into the software they build, allowing them to innovate and focus on their core missions. The Company is headquartered in San Francisco, California
That probably doesn’t mean much, but essentially if you work at a company that has multiple applications like Workday or Snowflake, Okta makes sure that users can access the appropriate applications based on who they are (their ‘identity’). This is what their Workforce Identity Product does. The Customer Identity Cloud does something similar for a company’s customers.
Okta’s products are increasingly relevant as more companies move their infrastructure to the cloud where they use a range of different applications. On average, companies in the U.S. have about 105 apps today. Companies also seem to be trying to move away from being a “Microsoft shop” and reduce their dependency on any one single software vendor.
These reasons are likely why Okta has grown revenue from $600M in 2019 to $2.6B today. Okta’s revenue growth has averaged 36% for the last five years, but in the last few quarters that has fallen to 16-18%. This has the market spooked and as a result the stock is down 7% YTD while the S&P 500 is up 28%.
The Set Up for Investors
In theory, Okta is cheap. Smartsheet got taken private a few months ago at 8x gross profits and was growing topline at about the same rate as Okta. A similar take-private acquisition here would imply a 20% premium to the current price.
If a company like Salesforce were to acquire Okta and get rid of all Okta’s salespeople over time, they’d be able to generate $1B in profits from the business each year, so you’d expect an acquirer to pay somewhere between $10B to $20B for Okta. The current market cap is $13B.
The slowdown in revenue growth could also be temporary as a lot of companies laid off employees in 2023. Given the annual contract structure the effect of those reductions in seats would only kick in now and that’s why revenue growth may have stalled. As hiring picks up or at least stops falling, Okta could revert to 20% + revenue growth.
On the flip side, Okta may be cheap for a reason. Zsclaer, which did $2.2B in revenue in its latest fiscal year, is growing 30% YoY vs Okta’s 15%. It’s possible that Okta is struggling to compete against Microsoft Azure AD making acquiring new customers a real challenge. Also, if you believe that in the long term AI is going to displace white collar jobs there may just be fewer licenses to sell as all companies shrink their workforce. This would be a meaningful headwind for Okta.
I’m inclined to put this in the ‘too hard’ pile because it’s not a business I understand well, but it feels like an asymmetric bet here where the downside is about 20% and the upside is 50-100%. The upside case is based on Okta growing revenue about 10% a year for the next five years bringing them to $5B in ARR. At a 20% net income margin, they’d be making $1B in net income and the market would assign a 20-25x multiple to this given the stickiness of the product. In this scenario, you would double your money over five years. That’s a 15% compound annual return.
I have a small position in Okta because I’m a sucker for asymmetrical bets. Select financials here.
Notes
1. Okta may be a cautionary tale for Palantir shareholders. If you bought Okta stock in 2019 you’ve lost money even though revenue has 6x’d since then. That’s because you were paying 30x revenue and it now trades at 5x revenue. Palantir is at 50x revenue currently.
2. Given they’re the dominant identity player they are targeted by hackers. An incident could immediately wipe 10- 20% off the stock price as we saw in October 2023 and with Crowdstike earlier this year.