Okta: Still Well Positioned To Ride On This Long-Term Trend (NASDAQ:OKTA) (2024)

Investment overview

I give a buy rating for Okta (NASDAQ:OKTA) as I expect the business to continue benefiting from the long-term growth tailwind stemmed from the ongoing digitalization trend that necessitates more cybersecurity needs by businesses. Based on the 4Q24 results, the recent security incident has not resulted in any material impacts. The strong renewal and adoption trend among large customers further supports this. New products and a restructured sales model should aid in driving growth acceleration in the near term.

Business description

OKTA is in the business of providing Identity Access Management [IAM] as well as Consumer Identity and Access Management (CIAM), Single Sign-On (SSO), Multi-Factor Authentication (MFA), and other identity management solutions, as well as Identity Governance and Administration (IGA) and Privilege Access Management (PAM). OKTA targets both B2B and B2C customers, where it provides relevant software development kits, APIs, and identity management services to its customers' application developers. Breaking down revenue by geography, OKTA has gradually expanded its revenue exposure overseas, with US exposure falling from 84% in FY20 to 78% in FY24. OKTA's competitive advantage stems from its leading position in the industry, where reputation is extremely important due to the nature of the product. In addition, OKTA uses cloud deployment and an open-platform approach that enables fast integration with other cloud applications, which I view as a moat against legacy solution providers.

Recent security incident is a past event

As I noted above, reputation is a key competitive advantage in this industry because of the nature of offering "security solutions," which must be trustworthy and reliable. OKTA shares took a huge beating last October because of the security incident, and the worry is whether customers will continue subscribing to OKTA once their contracts are up or whether it will impact growth in the future since customers are now more wary about using OKTA. Based on the performance and forward-looking comments, I believe this is now a past event for OKTA.

In the 4Q24 earnings, management indicated that they did not see a material impact from its October security incident, and the results were absolutely solid. OKTA reported revenue of $605 million for the quarter, 3% above consensus. Its EBIT margin of 21.3% also beat estimates of 17.6%. FY25 guidance was even upgraded to the above preliminary guidance given last quarter, now indicating expectations for revenue growth of 10%-11% y/y vs. the prior guide of 10%, operating margin of 18-19% vs. the prior guide of 17%, and FCF margin of 21% vs. the prior guide of =>19%. I would also note that OKTA continues to see mid-90% renewal rates, and average contract lengths hit a 2-year high of ~2.5 years, which I believe highlights customer willingness to maintain longer-term commitments with OKTA. Large enterprises were also apparently not worked up by this security incident, as OKTA saw customers with >$1 million in annual contract value [ACV] grow the fastest in the 4Q24 quarter, growing 30% to almost 400 customers.

Cybersecurity industry long-term growth opportunity

It is clear that the world still has plenty of room to shift workloads into the cloud, and the trend is moving in the right direction. The benefits of using cloud resources come at a cost to companies, and there is exposure to cyberthreats, which are arguably a lot harder to deter than a physical "threat." For instance, in the case of identity management, detecting and preventing non-authorized personnel is a lot easier in the physical world, but that is not the case in the digital world. Professional hackers are able to hide their digital presence behind strings of code that are virtually impossible for a normal employee to detect. Hence, I see a growing demand for OKTA over the long term. According to the most recent presentation by OKTA, the TAM is sized at $80 billion, and at $2.26 billion of revenue (FY24), OKTA is less than 3% of the market. My bullish view is in line with Gartner's forecast that IAM solutions are going to grow at a high-teens CAGR through 2027.

If I were to further split down the TAM growth drivers, I believe they are:

1. Businesses adoption of new SaaS solutions drives the need for more IAM solutions, as they are more vulnerable points in the business tech stack.
2. More stringent regulatory rules that, if disregarded, could result in hefty fines, necessitate more security controls which drives the need for cybersecurity solutions.
3. New use cases, like those fueled by CIAM and the Internet of Things (IoT), which will likely keep expanding at a rapid pace as the world continues to digitize.

New product and new sales strategy to drive growth

There are two visible growth catalysts that should drive growth in the near term. Firstly, OKTA's Spera (acquired in December 2023) solution. This acquisition is timely, in my opinion, as I expect strong adoption ahead given the rising trend of hackers using stolen credentials. In fact, customers have already shown great interest in the product. Second, I believe that OKTA's sales productivity will improve as a result of the realignment of their sales team. A "hunter-farmer" model is being put into place by management to target SMBs, along with new executive hires for go-to-market efforts. In order to achieve better results with both new and existing customers, I believe it is necessary to separate customer upsells from new customer acquisitions. As a result, I expect increased sales productivity throughout the year, which will help the company's growth accelerate back up to the high teens (and most likely above industry level given OKTA is a leading solution provider).

Customers are super interested in they're super interested in both, Identity Security and specifically the Spera acquisition. Company 4Q24 earnings

Valuation

Based on my research and analysis, my expected target price for OKTA is $112.

• Revenue should grow 13% in FY25 and 17% in FY26. My FY25 growth estimate is higher than what management is guiding, as I believe the guide is too conservative. Firstly, 1Q25 is guided to grow at 16.5% at the midpoint, which means 2-4Q25 is implied to see major deceleration - something I viewed as unlikely given the expected recovery in the macro environment, new product launches, and a new sales model. Also, management guidance has the tendency to be conservative, as reported revenue figures have always come in ~1.5% higher. In FY26, I expect OKTA to see growth reversion to industry-levels (high teens) as macro conditions become more stable and more businesses invest in cybersecurity as it is a necessity they cannot avoid forever.
• The stock should trade at a 6x forward revenue multiple. I got to this figure by comparing OKTA's growth and margin to Fortinet (FTNT). I expect OKTA to trade at a 1x discount compared to FTNT despite having similar expected growth rates (high teens) because FTNT is a much more profitable business (FTNT has an adj EBIT margin of 28.4% compared to OKTA's adj EBIT margin of 14%).

Risk

I believe the market has given OKTA enough benefit of doubt that the security incident will not happen again. The biggest risk here is if the security incident stems from a structural problem that OKTA failed to detect. If true, another similar incident could happen again, and customers might not be as forgiving anymore. OKTA's reputation would also be tarnished, making it hard to regain the trust of customers, thereby impacting both retention rates and growth.

Conclusion

I give a buy rating for OKTA. The long-term trend of digitalization and increasing cyber threats creates a massive TAM for OKTA's IAM solutions. In the near-term, I expect new products like Spera and a focus on SMBs to drive near-term growth. While the security incident is a risk, OKTA's recent performance suggests it's a past event.

May Investing Ideas