Okta: Huge Disconnect Between Rhetoric And Reality

Okta: Huge Disconnect Between Rhetoric And Reality

Investment Thesis

Okta (OKTA) is a stock market darling with a huge disconnect between its valuation and its fundamentals. It’s a case of rhetoric over reality. I argue that is unreasonable to expect that the next two years will be anywhere near as rewarding as the previous two years.

The evidence points to a steadily decelerating revenue growth rate combined with a steadily accelarating multiple to sales. At close to 40 times sales, this SaaS stock is incredibly hot, and with a negative risk-reward profile. It’s best to side-step this investment rather than ride the momentum.

Putting Fundamentals Into Perspective

Source: author’s calculations, ***high-end fiscal 2021 guidance

Okta’s revenue growth rate is steadily and consistently declining. If for fiscal 2020 it was growing at very close to 50% year-over-year, right now, for fiscal 2021 it is looking to grow at 33% year-over-year.

Even if investors are banking on the fact that Okta is low-balling their guidance in an attempt to impress the Street, I do question what fiscal 2022 will look like?

Indeed, considering that Okta’s billings are also 42% as of Q1 2021, I would surmise that the days when Okta was growing at close to 50% are for now gone into the rearview.

Having said that, Okta’s CEO Todd McKinnon was quick to preempt this line of thinking amongst analysts and investors noting that Okta had some contracts getting pushed out slightly due to COVID. Hence reinforcing for clarity that these meaningful contracts have not been cancel, but simply pushed out.

What Makes Okta So Attractive?

Mckinnon declares that work-from-home has played a meaningful role in ramping up the demand for a seamless secure identification platform, with enterprises, government agencies, and SMBs demanding both on-prem and cloud-hosted servers requiring Okta’s suite of products.

One standout win during the recent quarter was FedEx (FDX) where it required more than 85,000 employees to have a secure sign up within a very short period of time.

Indeed, the demand for Okta’s Single Sign-On (‘SSO’) product is only going to increase given the requirements for companies and agencies to connect from anywhere in a zero-trust environment.

Arguably, Okta’s 121% dollar-based net retention rate is extremely attractive. Not only does this point towards a very low customer churn rate (practically non-existent), but it also demonstrates Okta’s ability to expand customer relations with added revenue streams, with T-Mobile (TMUS) as an example.

Thus, all considered, it’s easy to see why this revenue growth story is so appealing, right? Well, not so fast.

Auditors Raise a Yellow Flag

On page 71 of the 10-K, the auditors question Okta’s revenue recognition policy. Here’s an excerpt

Auditing the Company’s accounting for revenue recognition was challenging […] certain non-standard terms and conditions required judgment to identify the distinct performance obligations and determine the timing of revenue recognition.

In layman’s terms, the auditors have some doubts over Okta’s revenues. Please see below:

In the red box, we can see accounts receivables are negative for all three years. In other words, revenue is getting booked in, but the cash is not following through.

Financial Position Remains Flexible

For now, cash is unlikely to be a big problem for the bull thesis. Okta’s balance sheet is strong and flexible with a net cash position of approximately $500 million.

Given that Okta’s biggest cost is its stock-based compensation which amounted to $127 million for fiscal 2020, its cash flows from operations are relatively reasonable at an annualized run-rate of approximately $150 million.

In other words, management is unlikely to have any problems in diluting its shareholders, given that the investors’ appetite for its shares remain so high. And this leads me to question the upside potential?

Valuation — Insufficient Margin of Safety

Having discussed the fact that Okta’s revenue growth rates are decelerating, I fail to understand how investors can possibly argue that paying an increasing large multiple to sales leaves investors with any further upside potential.

Source: author’s calculations

While acknowledging that Okta is by far a leader in identity management platforms, I nevertheless question what upside potential could arguably be now left here?

Furthermore, investors still have no real understanding of what its profit profile could turn out to be. Even while pushing aside its real and high stock-based compensation, even on a non-GAAP metric, Okta is likely to remain unprofitable for some time.

While I understand that Okta is investing for growth, and that it has no intention to turn a profit anytime soon, it’s nevertheless interesting that despite the expectation of adding approximately $200 million in revenues to its top line for the year ahead, its non-GAAP operating profits is not benefiting from much, if any operating leverage, as its non-GAAP operating losses are expected to be around $30 million compared with $49 million for fiscal 2020.

The Bottom Line

Okta’s share price trades at an all-time high, consequently, all shareholders will be holding gains, and have warm fuzzy feelings towards the company (read stock) and will be unwilling to ask difficult questions from their investment. Specifically, investors will not be asking whether there’s any further upside potential ahead.

For now, shareholders are highly likely to remain buy-and-hold forever shareholders of Okta even though the rational argument as to whether it’s a reasonably priced investment opportunity has long ago departed from the thesis here.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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.

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