Aside from adopting a recession-proof dividend growth investing strategy, risk-averse retail investors still interested in tech stocks should put a few criteria on their checklist. Look for high-margin software-as-a–service (SaaS) stocks because conventional wisdom says they are financially in a good position to become profitable (eventually) while maintaining a high-growth tempo. SaaS stocks should be able to maintain high net and gross retention rates, demonstrating an ability to both upsell to and keep existing customers. Finally, it would be preferable if this SaaS stock offered a solution its customers can’t live without that doesn’t involve porn, even when times are hard (no pun intended).
One obvious category is cybersecurity. As the old saying goes, there are two types of companies in the world: those who have been hacked and those who will be hacked. It’s not just anecdotal. More than 80% of companies will experience a data breach (or three) at some point, according to IBM Security’s annual Cost of a Data Breach report. The global average cost of a data breach was $4.35 million in 2022. Just like healthcare, the average cost of a data breach in the United States was much higher than the global average at $9.4 million. Stolen or compromised credentials were not only the most common cause of a data breach but took the longest time to identify at 327 days, IBM Security reported.
More than 4% of our Nanalyze Disruptive Tech Portfolio is allocated to cybersecurity, because every company needs protection from hackers with millions of dollars at stake. An obvious play is Okta (OKTA), the market leader in identity and access management (IAM). Okta’s cloud-based IAM platform is supposed to ensure the right users have the right level of access to the right piece of technology they are trying to log on to. This has become especially important with dispersed workforces accessing sensitive networks and applications outside the circle of company trust. Shares of Okta stock must be going through the roof, right?
The Okta Stock Slide
Not so much. While it appears that the company has mostly put an embarrassing hack incident behind it, Okta has yet to earn back the love investors first showered on the stock since its IPO in April 2017 when the company went public at a valuation of $1.5 billion.
Generally, we avoid putting too much stock in stock performance if we trust the theme and have the data from the company to back up our faith. That’s because it’s easy to cherry pick a time period that reinforces our own biases. In this case, however, six years does provide a long enough time horizon for analysis. We can see that Okta stock has outperformed the tech-heavy Invesco QQQ ETF (QQQ) by 30% despite the recent year-long slide. It’s also obvious that Okta stock rode the post-pandemic gravy train until the whole market went off the tracks. No one can predict bottom (and 95% of analysts can’t beat benchmarks), but we can see if there is enough upside to justify adding to our position now that Okta stock has a simple valuation ratio (market cap/annualized revenues) of about 5. Anything higher than 20 is too richly valued.
Why is Okta Stock So Cheap?
On the surface, Okta stock scratches just about every SaaSy itch. Strong revenue growth? How about nearly $1.9 billion in fiscal year 2023, up 30% from a year ago. Annual recurring revenues? About 97% of total revenues are subscriptions with an average term length of more than 2.5 years. The company is projecting 2024 revenues between $2.155 billion and $2.170 billion, representing growth of 16% to 17%. Gross margin is 71% and net retention rate clocked in at 120%, meaning existing customers spent an additional 20% more on Okta products. Gross retention rate is somewhere in the mid-90% range. At the beginning of the year, the company had 17,600 customers – including biggies like Amazon, CrowdStrike, Google, Microsoft, and Salesforce – after adding 2,600 new names over the last 12 months.
So, why are investors apparently still skeptical? There are probably a number of reasons why Okta stock is still dragging. Some of the key metrics like new customers (adding half as many as the year before) and net retention are looking a little soft. Gross margin is underwhelming for a SaaS stock. Management is talking about profitability – and cut 5% of the workforce not long ago – but that goal is probably still a ways down the road. Debt is somewhere in the neighborhood of $2.2 billion, though the company also has $2.6 in cash and assets. There has also been some rumblings around the circumstances involving company executives selling off big chunks of shares. Last year’s hacking incident and management’s less-than-stellar response may still be lingering in some investors’ minds as well.
Finally, there’s the $6.5 billion that Okta paid to acquire one of its chief competitors, Auth0, in 2021. There were (are?) reportedly some issues in integrating the two companies, which largely serve two different segments within the IAM market. Okta is focused on workforce identity and access, while Auth0 mainly serves the consumer security side. Reportedly, the two companies only shared about 300 customers prior to the merger. In theory, the acquisition should be complementary once the kinks are worked out. And, in fact, we see revenues moving toward a 50-50 split between workforce and consumer (though currently, it’s more like 60-40). On the other hand, we would not be the first to wonder why Okta could not have built its own solutions with the $223 million it spent on R&D in 2021 when it acquired Auth0.
Consolidation and Competition in Identity Management
Our interest in continuing to invest in Okta stock boils down to whether we think (1) Okta is a quality company with (2) a leading market position and (3) a big enough total addressable market (TAM) with enough room to run. While there have been enough missteps to make us wonder about the first premise, the results are undeniable, with Okta considered the best in its industry, with an estimated TAM of $80 billion (representing just 2.5% penetration):
In a previous piece on Okta, we broke down some of the leading competitors. Microsoft is obviously the 800-pound gorilla and needs no introduction. We did do a deep dive into the ForgeRock identity platform before deciding that we preferred Okta, which is something like an order of magnitude bigger in market cap and revenue. Another name on the leader board, OneLogin, was acquired by One Identity, yet another player in the IAM field. In turn, One Identity is part of Quest Software, which itself was acquired in 2021 by Clearlake Capital, a private equity group.
A potentially bigger rival to Okta is another private equity group out of Chicago called Thomas Bravo. Last year, Thomas Bravo acquired three IAM companies for a combined $12 billion, including market leaders ForgeRock and Ping Identity. The third acquisition was SailPoint for $6.9 billion – more than the other two combined. In fact, the private equity firm has a portfolio of nearly 30 security companies in which it has invested or acquired, including yet a fourth identity cybersecurity company called Delinea (formerly Centrify) that it purchased in 2018. (A fifth IAM company, Idaptive, that was spun out of Delinea was sold off in 2020 for $70 million.)
No one knows what the end game is here. Is Thomas Bravo putting together a dream team in identity management? Is Okta a potential target? That would certainly give the PE firm a commanding portfolio in the market, enough to go head-to-head with other players like Microsoft and IBM. The firm has certainly shown a willingness to spend big bucks, with a reported 100 total acquisitions, according to Crunchbase. For instance, Thomas Bravo paid $12.3 billion in 2021 for software company Proofpoint, which provides cloud-based email security, e-discovery, and compliance solutions to protect sensitive business data. At a market cap that has dipped below $11 billion, Okta could be an attractive buy at that valuation. While Microsoft could be a suitor, it is more likely to draw regulatory scrutiny.
Conclusion
Retail investors who believe Okta stock is a winner in identity management cybersecurity haven’t had a chance to buy into the company at this price since January 2019. While no one can predict when a stock or a market will hit bottom, there are enough headwinds right now that we don’t feel any urgency to pick up additional shares in Okta stock (even if we hadn’t already maxed this position out). Part of the story behind the strong revenue growth was the Auth0 acquisition, so it will be worth watching how the combined entity can grow organically together. The bigger picture of consolidation is also worth watching, especially with Thomas Bravo potentially cornering a big corner of the identity access market.
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