Okta: Upgraded As Management Drives Focused 'Go-To-Market' Strategies And Expands Margins (2024)

Introduction & investment thesis

Okta (NASDAQ:OKTA) is a cloud-based identity and access management company that has performed more or less at par with the S&P 500 and Nasdaq 100 YTD. I initiated a “hold” rating on the stock in February, and my thesis was predicated on my belief that the company would see a slowdown in pipeline growth and deal closure rates given the security breach incident it faced in October. While the company had been making strides to improve profitability, I believed that the stock was a “hold” given the uncertainties that lay ahead. Since the time of my “hold” rating, the stock has climbed 14%.

The company reported its Q4 FY24 earnings in late February, and after revisiting the earnings performance and management commentary, I have decided to upgrade my rating from “hold” to "buy." While the company is indeed going to see a slowdown in its projected revenue growth rate in FY25 at 10–11%, I believe management is committed to reigniting its long-term growth story as it realigns its sales team to drive more focused activities for customer acquisition and upselling. At the same time, the company is leveraging their partner ecosystem to win a higher volume of large customer deals while projecting to grow their profit margins by 450 basis points YoY to 18.5%. During the earnings call, management announced its Okta Security Identity Commitment initiative to reinforce the security of their access management platform while building out customer best practices at the same time and launching new products.

I believe these are steps in the right direction, which should set the company to grow in the mid-teens range over the next couple of years, which would be a sign of success while it continues to expand its margins. Given where the stock is currently trading, I believe it presents an attractive entry point for long-term investors from a risk-reward standpoint, with an upside of 27%.

A quick primer on Okta

Okta is a cloud software platform that secures digital access for people and organizations on cloud networks. The company offers its access management products to its customers via its Workforce Identity Cloud and Customer Identity Cloud. Customers use Okta’s products to manage access to their organization’s resources, such as cloud and mobile apps, servers, APIs, and other IT infrastructure.

In terms of its business model, Okta operates on a subscription-based model by selling multi-year subscriptions for Okta’s cloud platform. As of its most recent Q4 FY24 quarter, Okta reported that it had 18,950 customers, which was 7.6% more than the previous year.

The good: Growth in customers with $100K+ ACV, Partner ecosystem, product innovation with commitment to security

Okta reported its Q4 FY24 earnings report, where both revenue and earnings exceeded expectations. Revenue grew 19% YoY for the full year FY24 to $605M, while Subscription revenue grew 20% YoY to $591M, contributing close to 98% of Total Revenue. One of the biggest priorities of management is to reignite growth in the business in FY25 and beyond as it revisits its go-to-market strategies to drive deeper adoption of its solutions and better leverage their partner ecosystem while continuing to drive product innovation.

As of FY24, Okta has 18,950 customers, up 7.6% YoY. Meanwhile, customers with $100K in Annual Contract Value (ACV) grew to 4,485 in FY24, up 14% YoY. I believe this is indicating that customers are continuing to increase their spend and adoption on the platform, even though the rate of new customer additions has been slower, which can be explained by the current uncertainties of the macroeconomic environment as well as the strength of large enterprise customers relative to small and mid-size businesses (SMBs).

During the earnings call, Brett Tighe, CFO of Okta, mentioned that the company has been seeing success with signing a record number of contracts of $1M+ ACV, growing 30% in Q4. In fact, management is now taking an active measure to redesign the structure of their sales team, whereby they will have a team of account executives that focuses on driving customer acquisition and a separate team that will focus on driving upsells within their existing 18,950 customer base, which I believe will drive a more focused effort to scale the company to the $5B mark, in line with management’s long-term vision.

At the same time, Okta continues to leverage their partner ecosystem, which includes independent software vendors (ISVs) and solution providers, where they are seeing some of their strongest customer wins with $1M+ ACV, with 8 out of the 10 deals in Q4 that were resold or influenced by partners. In fact, according to management commentary during the earnings call, “40% of their business mix is invoiced through indirect channel partners, up from about 33% a couple of years ago,” as they introduced their partner framework called Elevate last year to better align partner incentives to the total value they deliver to Okta. Recently, Okta also entered into an agreement with SoftBank as a managed service provider, as it looks to expand in the Japanese market, where it would allow them to reach 16,000 Japanese companies and 2.4M devices that utilize the managed service.

In terms of product innovation, Okta launched an initiative called Okta Security Identity Commitment, which encompasses their internal program Bedrock that they built after the security breach that the company faced in October in order to level up and reinforce their entire access management platform and make it more resilient. The Okta Security Identity Commitment would further build out customer best practices so that their customers are highly protected. This is what the CEO talked about in the earnings call that demonstrated their commitment to lead by example at a time where identity is an increasingly growing attack vector.

“Okta Threat Insights has detected and prevented over 2 billion malicious requests in the last 30 days alone; we've reduced credential stuffing attempts and malicious bot traffic by more than 90% for some of our largest customers just over the past 90 days, and we're shaping industry best practices with 100% of Okta employees using Okta FastPass phishing-resistant password-less authentication. I encourage you to read more about the Okta Security Identity Commitment in the blog we posted today.”

Simultaneously, the company also launched Okta Identity Governance and Okta Privileged Access in order to combine the benefits of access management, governance, and privilege access across a unified platform and enable organizations to make it easier for their employees to securely access applications and effectively shield from threat actors.

Finally, I believe that the brightest spot for Okta is its growing profitability, where non-GAAP operating income grew to $310M from a loss of -$10M in FY23, at a margin of 14%, an improvement of 1,500 basis points. While the growing number of customers with $100K+ ACV helped the company gain operating leverage, it also enabled it to streamline its operating expenses, which grew 3% YoY, much slower than the 19% YoY growth in revenue, with Sales and Marketing spend as a percentage of revenue dropping to 45%, compared to 57% a year ago on a GAAP basis.

The bad: Slowing cRPO and NRR could spell trouble for Okta’s growth story, given the competitive landscape.

In the previous post, I talked about the competitive pressures Okta faces from deep-pocketed players such as Microsoft (NASDAQ:MSFT) and IBM (NYSE:IBM), where both of these companies tend to bundle their identity management and access management solutions within their cloud computing products. While this keeps the pressure on Okta to continually innovate, it is currently recognized as a market leader in the access management space.

However, my bigger concern is around the growth rate of Current Remaining Performance Obligations (cRPO), which is trending lower than the Revenue growth rate of 16% in Q4. Furthermore, the company has outlined its forward guidance for Q1, where we can see that cRPO is expected to trend even lower to 13% YoY, which is indicating that the company is facing a higher rate of churn in the form of non-renewals or account downgrades, relative to the volume of upsells and new logo additions. In fact, when we look at the Net Retention Rate (NRR), it stands at 111%, which has been trending downward throughout FY24. While an NRR of 111% is still pretty good, I believe this is a metric to monitor carefully in the upcoming quarters to assess whether the company is seeing signs of a rebound in its growth story as it aligns its sales team to drive more focused acquisition and upsell activities while leveraging its partner ecosystem to drive higher ACV customers.

Tying it together: Okta is a “buy”.

Looking forward to FY25, Okta is projected to grow its revenue by 10–11% YoY to $2.5B. This is a slowdown from its current levels, as cRPO is trending lower. Meanwhile, it is expected to further improve its non-GAAP operating margin YoY by approximately 450 basis points to 18.5%. This would translate to a non-GAAP operating income of $462M, growing 49% YoY.

Assuming that Okta is able to bring back its growth rate in the low to mid teens region over the next couple of years, it should generate close to $3.2B in revenue by FY27. Assuming that non-GAAP operating margin grows to 22% during this period of time, as the company successfully drives larger deal sizes and increases spend on its platform from its existing customer cohorts, which allows it to further streamline its operating expenses, it should generate a non-GAAP operating income of $702M, equivalent to a present value of $580M, when discounted at 10%.

Taking the S&P 500 as a proxy, where its companies grow their earnings on average by 8% over a 10-year period, with a price-to-earnings ratio of 15–18, I believe that Okta should be trading at twice the forward multiple. This would translate to a PE ratio of 34, or a price target of $117, representing an upside of 27% from its current levels, making it a buy.

Conclusions

While slowing cRPO and NRR are areas of concern, I believe the company is taking steps in the right direction with its go-to-market strategies and product innovation roadmap, which should help drive growth at least in the low teens region in the coming years. Assessing both the “good” and the "bad," I will believe the stock is attractively priced with a possible upside of 27%, making it a “buy”.

Amrita Roy