Okta: Why I’m Initiating With A Buy (NASDAQ:OKTA) (2024)

Investment thesis:

I'm initiating Okta (NASDAQ:OKTA) with a buy rating ahead of 2Q25 earnings because I believe the negatives have been priced in after last quarter's disappointing outlook, and there should be limited downside for the rest of 2024. This provides what I see as an attractive entry point into a leading identify cybersecurity stock for longer-term investors. In my opinion, management's efforts in new product innovations and cost savings will show up on the top line through FY25; the company already raised its FY25 guidance to $2.53-$2.54 billion in revenue compared to earlier expectations of $2.50 billion and adjusted earnings of $2.35-$2.40 per share versus the expected estimate of $2.32 per share. I think there's more room for upward revisions for FY25 towards the end of the year as management is being conservative to manage expectations.

I don't see an overnight recovery for the stock price, but I think that the company is on track to maneuver the current rough economic backdrop and beat expectations in 2HFY25. I also think management is doing well in keeping the boat afloat in light of the recent breaches and macro headwinds weighing on customer spending through cost reductions. The image below shows the improved operating profitability of the company with a non-GAAP operating margin of 13.7% for FY24, up from (0.5)% in FY23 and (5.7)% in FY22. GAAP operating loss recorded a huge drop from $160 million in a year ago quarter to $47 million this quarter, 1Q25. GAAP net loss also improved from a year ago quarter at $119 million to $40 million in 1Q25. I understand profitability is a concern for investors when looking at Okta, GAAP profitability in specific. I think the company's performance in 1HFY25 and year-over-year metrics underscore that Okta is edging close to profitability on a GAAP basis. Again, I don't expect we'll see this happen next quarter, but I do think the company is now be better positioned to achieve this than it was a year ago and will be better positioned in a year from now. I would urge investors to take into account that Okta is dealing with an uncertain macro backdrop involving longer deal cycles and tighter budgets, which can weigh on revenue growth as well as profitability. Macro recovery anticipated for next year should help ease the path towards GAAP profitability, in my opinion. Plus, I think it's noteworthy that Okta achieved "record free cash flow, resulting in a free cash flow margin of 35%," as stated on their earnings call.

The stock has been underperforming against the S&P500 on the 3-month mark. While the S&P500 recorded a 7.2% increase, Okta was at a 9.5% decrease, as seen below. This means Okta has underperformed by 16%, confirming my belief that the bad news is priced in at current levels.

Over the one-month chart, Okta slightly outperformed the S&P500, recording a 5% increase against the latter with a 4.3% increase. I believe this means that the weakness has been recognized, and the market is adjusting to the recent macro headwinds and the security breaches, which I will get into in a minute.

So why buy the stock?

I'm initiating this buy on two main factors:

1. The bad news has been priced into the stock, and by bad news, I'm referring to management's guarded commentary on any near-term catalyst and disappointing 2Q outlook. Okta reported 1Q25 earnings on May 29th, and the stock closed ~8% lower on May 30th, a day after the last earnings call. I think the market has now recognized the rough macro backdrop capping material in the near term and the seasonality of Q2, which, according to management, is the "lowest quarter of the year." With this in mind, I think the company is now better positioned to outperform expectations.

2. I think Okta has a lot going for it in the mid-to-long run, considering the ballooning nature of the cybersecurity space and Okta's consolidated position as an identity security player through its Auth0 platform; the latter is an identity management platform, known for its flexibility as a drop-in solution "to add authentication and authorization services to your applications" saving organizations and customers the "cost, time, and risk that come with building your own solution to authenticate and authorize users" and was acquired by Okta in 2021.

What's (not) keeping me up at night?

It's no surprise that Okta lost some of its credibility as a cybersecurity company with the two incidents of security breaches back in 2022 and 2023. The company paid a high price, particularly after last year's October data breach, which caused a pullback of over 21%. The stock regained its losses, growing 66% to a high of $111.4 per share in March 2024. Okta has seen a pullback from its March high since; down 15% and hitting a low of $86 per share. I think we could see another rally after the recent pullback, especially as expectations have readjusted in response to last quarter's call and management's guarded guidance; I believe the market opportunity for cybersecurity remains intact.

It's important to note that Okta isn't the only one space facing such breaches; other companies in the tech sector are feeling the grunt of increased cybercrime. Microsoft (MSFT) back in May 2023, Google (GOOG) fi in February 2023, ChatGPT in March 2023, Snowflake (SNOW) in May 2024, and AT&T (T) in April 2024 were all affected by the new trend of cybersecurity attacks. I'm not too worried, as this is to be expected with the AI boom and the rise in cloud computing and migration since the pandemic. I am watching the projections of cybercrime over the next few years, as I see that as a good indicator of the demand environment when it comes to cybersecurity offerings such as Okta's. According to Statista Market Insights estimates, the cost of cybercrime globally is forecasted to grow exponentially over the next four years from $9.2 trillion in 2024 up to $13.8 trillion by 2028, as shown below. The expanding threat landscape is an assurance that cybersecurity spending is no longer optional, it's necessary. This indicates that cybersecurity spend should be relatively resilient until we overcome the macro slowdown we're seeing at the moment.

In my opinion, Okta, powered by Auth0, is at a huge advantage as it is a "leading identity partner" during these times when the need for cybersecurity is only increasing with the surge in cybercrime. This is a golden opportunity for Okta to up its clientele base. The cybersecurity market is ballooning, a positive for Okta as it is a leader in identity management. The cybersecurity space generates its revenue from two main products: security services and cyber solutions. According to Statista projections, as of June 2024, revenue in the cybersecurity market is projected to grow and reach US$185.7 billion, and security services market volume is also projected to grow and reach US$97.3 billion. CAGR is forecasted to be 7.9% (2024-2029) to reach a market volume of US$271.9 billion in 2029. As seen in the graph below, the cybersecurity market has been consistently increasing in size over the past few years and is forecasted to maintain that growth.

In the first quarter of 2024, "the average number of cyberattacks per organization per week reached 1308," a 28% increase quarter-over-quarter and a 5% increase year-over-year. The image below also showcases the numbers from the 2023 FBI's Internet Crime Report.

Cybercrime isn't bound to one industry; breaches are happening to all kinds of organizations. Okta offers identity solutions to every industry, including retail, financial services, healthcare, travel, hospitality, technology, energy, nonprofit, and the public sector. The latter, over the past few quarters, has emerged to be an "area of strength." According to management's last earnings call, "five out of our top six deals in Q1 were with public sector organizations." Public sector deals are usually bigger in size due to the organizations they're selling the services to being bigger, which means that ultimately, they "haven't been impacted like some of the SMB parts" of their business in the last few quarters due to macro headwinds. The majority of the public sector business is US-based, and the new public sector "win" this quarter for Okta is the Department of Defense. According to management's earnings call, the fastest growing customers are the "$1 million plus customers.. Growing faster than the overall customer count, 12% versus 6%". I think this pushes Okta's top-line growth and gives it the opportunity to exit 2025 better than it entered it.

Okta has two offerings:

1. Customer identity cloud deals with consumer and SaaS Apps across the industries mentioned through authenticating, authorizing, and securing access for apps, users, and devices

2. Workforce identity cloud deals with big organizations to secure employees, partners, and contractors in all aspects (governance, access, and privileged control).

The company makes the majority of its money through subscription fees. Other streams of revenue are minimal and include professional services fees. Through its SaaS business model, Okta's revenue comes from the number of customers it has, the number of users included in that, and the products used by these customers. According to the 1Q25 earnings presentation, Okta made 98% in revenue from subscriptions and only 2% in professional services, similar to the previous quarter and in line with the past few quarters. Total revenue was up 19% year-over-year, and subscription revenue was up 20% year-over-year. The graph below shows the breakdown of Okta's revenue through 2023 and 2024.

Valuation

Okta's price/earnings ratio for CY2024 is 39.7, significantly lower than the peer group average of 79.1. The stock's EV/Sales ratio for CY2024 is 5.7, also lower than the peer group average of 8.8 and its biggest competitor, Microsoft (MSFT), at 13.2. In my opinion, the stock is undervalued and is attractive at current levels. The market doesn't recognize Okta's growth potential, which makes the stock that more attractive for longer-term investors, as expectations for Okta are low enough now to warrant a beat in FY25.

Most analysts recommend the stock as a hold (as seen below); 22% of analysts are strong buys, ~27% are buys, over half analysts (~51%) are hold, and no analysts are sell. I get how this looks, but the Okta stock isn't for the faint-hearted. Where others are freaking out and selling the stock, this is your chance to get in and buckle up for a bumpy yet rewarding ride. According to Data from Refinitiv, the price target median for the stock was $110 in April and was consistently so through May and June, but only recently revised higher to be $113 at current levels. The mean also had a similar trend and was consistent from April to June at ~$114 and is currently at an increase of ~$1 and reached $115.5. The upward trajectory of the price targets reiterates my positive sentiment on the stock.

What Q1 results and guidance tell me about what's next

The company beat the top and bottom lines and recorded revenue of $617 million, a 1.9% increase quarter-over-quarter and 19% year-over-year, and EPS of $0.65, a 3% increase quarter-over-quarter and an impressive 195% increase year-over-year. Annualized subscription revenues also grew to $2.4 billion, with a 2% increase quarter-over-quarter and a 19.8% increase year-over-year. Expanding subscription gross margins recorded 83.5% with a 2% increase year-over-year and inline quarter-over-quarter.

This quarter came in with decent key metric numbers; cRPO beat management's expectations of 13% year-over-year and came up 15% year-over-year, and backlog grew to $3.36 billion, reflecting a 14% year-over-year growth. I say decent because these numbers are on par with the 4Q24, showing no or minimal decrease. I'm not too worried, as this has already been priced into the stock due to the recent events. I care about the cRPO as it is the "sum of Deferred Revenue and Backlog the company must deliver over the next twelve months" and it does well to foreshadow what subscription revenue will look through new customer bookings, renewals, and upsells. The company is also consistent with its RPO growth and reported an RPO of $3.6 billion in 1Q25, with a 14% increase year-over-year and in line quarter-over-quarter, as seen below. In my opinion, these are positive numbers considering the macro headwinds and the security incidents of October 2023; the demand for cybersecurity products is intact, and market expectations have adjusted for the near term.

The company did "incorporate some conservatism into our outlook as we continue to monitor potential impacts related to last year's security incident." This quarter's guidance, in my opinion, is guarded and understandably so. For 2Q25, management is expecting total revenue of $631- $633 million with a 13%- 14% growth year-over-year, versus a consensus of $632.9 million and cRPO of $1.95 -$1.96 billion with a 10%-11% growth year-over-year. The company is raising its outlook for FY25 but is still factoring in two main things: 1. Macroeconomic headwinds and 2. The security incident, although only minimal impact, was observed in Q1 and Q4, according to management.

I see more upside for Okta in 2H25 as management shows discipline in its spending and prioritizes "reigniting growth." I believe the company is positioned to exceed expectations.

I’m a retired Wall Street PM specializing in TMT; my educational background is a bachelor's in Finance and Economics, and an MBA from Columbia, after which I directly began my career on Wall Street. Since kickstarting my career, I’ve spent over two decades in the market navigating the technology landscape, focusing on risk mitigation through the dot com bubble, credit default of ‘08, and, more recently, with the AI boom. In one word, what I’d like my service to revolve around is momentum. I channel years of experience at top-ranked institutional sell-side and buy-side firms and first-hand experience in retail, biotech, and technology sectors to provide data-driven insights to capture momentum. I deep dive into market trends, scrutinize company fundamentals, and assess the disruptive potential of emerging technologies and growth opportunities. My service aims to act as a tool to maneuver the market landscape so that you can know when momentum begins and, equally important, when it’ll end. My investment strategy is simple. I specialize in tech sector investments, emphasizing risk management. I diversify within the sector, focusing on companies with solid fundamentals and innovative products; while I focus on European and U.S. stocks, I also informally cover Asia-based names that I believe have reasonable risk-reward profiles. My equity-focused approach aims to optimize returns in the tech landscape. I’ve built my wealth by navigating the technology landscape and am looking to extend my knowledge of the industry to help advance the retail guys' investment journey. I firmly believe that technology's exponential growth has reached a disruptive peak, with consumer demand for innovation soaring. This convergence presents a prime window of investment opportunity. The retail investor is becoming more curious and conscious of these developments, and I’d like to add to the knowledge in the field, helping guide their investments. As a contributor on Seeking Alpha, my motivation is to share my insights, research, and investment ideas with a wider audience of like-minded individuals.