Okta Earnings: More to Squeeze From Valuation?
August 30, 2019
Lead Tech Analyst
Okta is fundamentally weaker than many analysts believe, making its booming stock priced to perfection.
The company was early out of the gate for cloud-subscription IPOs in 2017, and the valuation has reaped the benefits of Wall Street’s enthusiasm for subscription models. However, a reasonable price to initiate Okta as a buy-and-hold investment is now in the rearview mirror, rendering it a momentum play. That will be important for investors when they review its earnings report for the three months through July after the stock market closes Wednesday.
Okta’s stock dropped 10% on weakening guidance for both revenue and earnings per share (EPS) in the March earnings report. The stock quickly recovered, as there was little adjustment given for lower EPS guidance.
Investors put that out of their mind, as the stock recovered with renewed momentum within a few days and has not looked back. Last quarter, Okta raised its guidance to expected losses of $0.45 to $0.49 per share, although this “improvement” is relative, as the original expectations of the full-year loss was at $0.22 per share prior to the March earnings report.
This article originally appeared on MarketWatch on August 28th, 2019.
Valuation has been an ongoing worry with Okta, as the company has the highest forward price-to-sales in its category, at 27, with a current price-to-sales of 34. Compare this to Workday at 12 forward price-to-sales, Veeva Systems (which is profitable) at 22, and Twilio at 15.
There is ample evidence that, although Okta is priced to perfection, it does not need to report perfection to continue its momentum. This is one red flag for a buy-and-hold strategy at current prices, but a positive sign for momentum trading. Eventually, the market will want perfection for the price it’s paying when macro conditions warrant more discernment.
For instance, many analysts are touting the stock for positive free cash flow (FCF), although this is from operating cash efficiencies. Okta does not have positive free cash flow from positive net income, which is something financial analysts are writing out of the script entirely.
Free cash flow becomes more indicative of financial health when net income is positive; to separate the two underweights profitability, which is a mistake for buy-and-hold investors (or analysts) when evaluating the stock. Free cash flow positive is much more celebratory when net income is positive.
In fact, Okta suffered a record net loss in the fiscal first quarter that ended in April. Okta’s loss widened nearly 200% year-over-year, to $51.9 million. This led to diluted EPS of negative 46 cents, compared with negative 25 cents in the year-earlier quarter.
Lastly, Okta is no longer a debt-free company and is carrying $275 million in convertible senior notes.
Wall Street is laser-focused on Okta’s top line, and is a little blind-sided to the bottom line as free cash flow and subscription growth were the only touted highlights from last quarter’s earnings report.
Okta posted 53% year-over-year growth in subscription services to $108.5 million, while professional services revenue grew 15% to $7 million. Total calculated billings hit $158.9 million, with trailing 12-month subscriptions jumping 55% to $488.2 million.
The increase in net losses from the most recent quarter was under-reported due to subscriptions driving revenue growth of 50% year-over-year.
In the upcoming earnings report, the bar for revenue is set to less than 40%, which is an easy hurdle for a subscription cloud company that has been posting 50%-plus revenue growth for many consecutive quarters.
Also Read: Microsoft Stock Price: Technical Analysis
Under the Hood
In Okta’s case, there are two areas I am watching more closely, as spending is substantial and executive decisions are slightly unusual.
The first is sales and marketing expenses, which are nearly two-thirds of revenue. At Workday, sales and marketing comprise 30% of revenue, Twilio is at about a third and Zoom Video Communications is at about half.
This signifies Okta needs to spend a lot to scale and maintain its footing. Selling, general and administrative (S&GA) expenses were nearly 85%, or $107 million, of $125 million in total revenue in the most recent quarter. Notably, Okta’s S&GA and research and development (R&D) exceed revenue at 114%.
The second clue is a few recent acquisitions that will hurt Okta’s financials. For instance, Okta’s $52.5 million purchase of early-stage startup Azuqua will dent operating expenses. (Early-stage startups tend to have thin margins, although exact numbers from Azuqua weren’t provided.)
There is also a recently announced $50 million venture fund. Creating venture funds is typically a positive, as companies including Twilio and Workday also have created venture funds to help incubate firms that use its product and services. However, in Okta’s case, it’s funding startups to help innovate the core product, which is concerning because Okta is not even profitable yet and is already looking for help to iterate the core product, rather than incubate to increase demand in the market.
Looking deeper, I believe Okta is throwing a lot of weight into product because the mega-cap cloud server companies are in the identity and access management (IAM) market. Okta has to provide a compelling reason to use an add-on service to Microsoft Azure, Google Cloud, Amazon’s AWS and IBM Cloud rather than use the in-house identity and access management service.
See: Beth Kindig runs a premium service that includes a forum on tech stocks where she answers questions from readers.
Okta does have a competitive advantage due to its superior product, which is confirmed by third-party analysts Gartner and Forrester. The one issue to consider for the long term is that larger rivals are going to protect their turf. Cloud infrastructure is a revenue segment that will determine the world’s most valuable company over the next few years, and Okta has an incredible feat ahead to remain more agile and to iterate faster than opponents that have bottomless amounts of cash. On that note, Okta could make a great acquisition for one of those companies, though any prospective suitor would have to overpay.
Okta is unlikely to miss estimates on revenue as the subscription model helps protect growth, yet other line items may continue to miss or weaken. Okta has no choice but to spend heavily on its market position — either through S&GA, R&D or acquisitions — to fend off larger cloud competitors that are a one-stop shop for identity and access management, and are currently engaged in a battle for cloud infrastructure.
Overall, Okta became a fundamentally weaker company in the past two quarters, yet the stock price does not reflect this, which is why it makes a better momentum play than a buy-and-hold. Previous earnings reports prove that although priced to perfection, the company does not need to report perfection in order for the stock to claw at a higher price-to-sales ratio.
Sign up for Analysis on the Best Tech Stocks
I’m an industry insider who writes free in-depth analysis on public tech companies. In the last 12 months, I predicted Facebook’s Q2 crash, Roku’s meteoric rise, Uber’s IPO flop, Zoom’s IPO success, Google’s revenue miss and more. Be industry-specific. Know more than the broader markets. Sign up now. I look forward to staying connected.
If you are a more serious investor, we have a premium service that offers institutional-level research and entry/exit options. This membership offers a competitive edge in identifying growth opportunities and reducing risk in the tech sector. Learn more here.
More To Explore
Slack’s missteps have now made the stock a ‘buy’ at the right price
Slack Technologies is the fastest-growing software-as-a-service (SaaS) company of all time and a Silicon Valley favorite, yet the direct public offering (DPO) clearly d...
Slack IPO: Pros and Cons
June 20th is the official date of the Slack IPO, although the technical term is not an IPO but rather a DPO for Direct Public Offering. Of the cloud software companies ...
Smoke and Mirrors: How Snap and Pinterest Hide User Attrition
Social media companies today are using smoke and mirrors to hide an important key metric. I’m going to pick on Pinterest first because the social media company recently...
Pure Play Tech Stocks to Benefit from IaaS Growth
This is the second article in a 2-part series. The first article “Best Bet for Growth Stocks in 2019? Secular IaaS.” can be accessed here.
FuboTV Delivers Record Numbers; Fantasy and Sports Betting on Deck
According to Fubo’s recent earnings call, a free-to-play app is scheduled to launch in Q3 and a sports betting app is scheduled to launch in Q4.
Up-Close on Strategy with Lead Analyst of the I/O Fund
Recently I joined Ed Gotham from CMC markets in the Opto Sessions podcast. I discussed what tech trends will shine in the next five to ten years, how I started I/O Fund, and how we spot the right tech
July Market Update: Is Inflation Overblown?
On February 16th, the dynamics of the market shifted as we saw the beginning of a large rotation away from the growth stocks that led us out of the 2020 bear market.
SentinelOne: Excessive Valuation Overshadows a Stellar Product
Cybersecurity firm SentinelOne had a its public offering late last month. The product is very promising as it automates cybersecurity, reducing human errors, fatigue and head count. However, the valua
Nasdaq100 Levels to Watch for the Next Leg Higher
Knox Ridley, the Portfolio Manager for the I/O Fund, has written an overview of the levels he is watching for the Nasdaq 100 and also why the Dow Transportation Index will help confirm if we see the n
Q1 Earnings Analysis for Etsy, Square, and Palantir
As earnings season winds down, we review earnings reports for popular growth tech stocks Etsy, Square, and Palantir.