My firm recently began using Okta for security log-in purposes. In line with what Peter Lynch would recommend, when you hear about adoption of a product, go and check out their stock. Often times, Lynch would hear his children talking about a new toy, he’d buy the stock and profit as the rest of Wall Street caught up to the story.
While Okta is not a toy company, it is a hot topic for today’s investors. In my experience, I’ve seen Okta used as a security portal for employees in order to access the cloud where important files or information may be held. A benefit is that its simple to use and its multi-factor login creates a secure authentication process without multiple log-ins. For its customer platform, you and I may be logging in to JetBlue’s website and everything looks right, but behind the scenes Okta is powering the customer experience and making it secure.
The bull case for Okta is that as Cloud adoption grows, so will security needs. We’ve all seen and heard about data breaches in the past, so it will clearly be a big focus in the future.
Peruse any one of Okta’s filings and it is clear they are bullish on the cloud and what it means for them. In fact, Cloud is mentioned 285 times in their S-1 and they note, “According to International Data Corporation, or IDC, in 2016, the Cloud Software market is expected to be $78.4 billion and the Custom Application Development market is expected to be $41.2 billion. We believe that our platform is well positioned to address a meaningful portion of these markets.”
Notice they don’t say that is their addressable market. The fact is, it is likely a fraction of that, but undoubtedly it will be big. This growth has started to show in Okta’s numbers. In the FY ended Jan-2016, Okta did just $86MM in sales and in the LTM period Jul-19, they did $487MM. That is a 64% CAGR!
As expected, Okta’s growth has started to slow. It is simply impossible to sustain that rate forever. Analysts expect however that it will grow top line ~30% through 2021.
Getting to the valuation:
Let’s just say we think Okta can grow at a 30% CAGR for the next 7 years. Their GP margins, given it is a subscription model mostly, grow at high incremental rates. I will assume 88%. Given security is a constantly evolving business, I will assume that R&D is fixed as a % of sales, but roughly half of sales and marketing is fixed vs. variable (and grow at inflation) and G&A and back office are 75% fixed (likely an assumption, honestly).
What we see above is that if everything goes right and they grow at a massive rate, the company is still trading at 20x EBITDA 7 years from now…. I don’t see why I would buy this when Facebook is growing 20% a year and trades at just 10.5x 2020.
So what do you need to believe? I would have to say investors are banking on AT LEAST 40% top line CAGR with massive EBITDA growth (negative to $1.4BN) and that still only gets you to 10.7x EBITDA…. looking 7 years out. To me, this is crazy.
While Okta has some benefits of being “entrenched” in its customer base, I don’t think switching costs are that high. My firm used something before we moved to Okta… we could move again if we deem we are more protected or offered more for the same price. This is a constant occurrence in Tech and especially in cyber security… constant cannibalization and forming something new and better… often at the expense of incumbents.