Okta: Racing Ahead To A Huge Valuation
Summary
- Okta reported Q4 results that shattered analyst expectations, sending shares skyrocketing near the $40 range.
- The company's revenues grew 59% y/y in Q4, one of the fastest growth rates for a company of its size.
- Operating cash flows also broke even in the quarter for the first time in the company's history.
- Guidance for FY19 was strong, but implied heavy deceleration in the back half of the year.
- Shares are extremely expensive at 11x forward revenues and are probably best avoided.
Okta (NASDAQ: OKTA), the single-sign on and identity management software company, has never failed to impress investors with its earnings results. Q4 (which Okta "pre-released" a week earlier, to much celebration) was no exception, with upside guidance goading investors into sending shares up to nearly $40.
Year to date, shares of Okta are already up more than 50%, far eclipsing the volatility seen in the broader market - which, as it currently stands at the time of writing, is about flat for the year as the market digests a flurry of headlines on inflation, tariffs, and most recently, the departure of chief economic adviser and ex-Goldman COO Gary Cohn. Despite turbulence in the broader markets, Okta has seen only one direction: up.
A lot of this rise is justified. I've been a long investor in Okta for most of the time since the company went public, and the outlook for Okta's product and market is incredible. Businesses are now using such a wide smorgasbord of applications that managing passwords and sign-ons, without an interface like Okta, has become a nightmare. And without much competition in the SSO space, Okta has been left to grow unchecked - case in point, the ~60% growth rate Okta saw this quarter basically defying gravity for a company at its ~$300 million run rate.
Additionally, note that Gartner named Okta a leader in its first-ever Magic Quadrant for Access Management (other leaders include Microsoft (NASDAQ: MSFT)), not only validating its space but essentially putting it at the top of the pack.
And while I do kick myself for having sold Okta too early, I don't regret making a sell decision grounded on overvaluation. It's pretty safe to say that's the territory Okta finds itself in now.
After the company's earnings rally, at a share price of $39.25, the company has a market cap of $4.04 billion; netting out its $229.7 million of balance sheet cash and no debt, Okta has an enterprise value of $3.81 billion. Against the company's revenue guidance of $343-$348 million for FY19, this represents an EV/FY19 revenue multiple of 11.0x. Okta has reached the absolute highest rung of software valuations in the double-digits, on par with the perennial high-value stocks like Workday (NASDAQ: WDAY) and Adobe (NASDAQ: ADBE).
Yet these latter two companies are much more mature and generate plenty of free cash flow, which is something Okta is just now beginning to do. Yes, it's growing at a much faster clip and deserves a premium revenue multiple - but with the stock sitting at 11x, it's hard to envision how much higher Okta can go. With deceleration baked into Okta's guidance for FY19 (49-50% growth for Q1 guidance against just 33-35% growth for the full year), as well as whiffs of possible competition from AWS, Okta's opportunities to soar substantially further are quite limited.
While the long term thesis for Okta and its business potential are still very much intact, now is a good point to take profits on the trade. With such a nosebleed valuation, Okta is much more likely to disappoint than to succeed in 2018.
Q4 download: huge growth, breakeven OCF
That being said, however, there is good reason for long investors to cheer after Okta posted its Q4 results. See the summary below:
Figure 1. Okta Q4 results
Source: Okta investor relations
Revenues in the quarter climbed 59% y/y to $77.8 million, eclipsing analyst estimates calling for $43.9 million (+51% y/y) by a healthy eight-point margin. Note also that this quarter's revenue growth represents barely any deceleration from the 61% growth Okta saw in Q3. With the company putting up these ~60% growth figures quarter after quarter since going public, it has established itself as one of the true "super-growers" in the software industry and a model for startups in Silicon Valley.
Equally as important - Okta also saw huge billings growth. Given that a subscription company signs multi-year deals that drive revenues far beyond the current quarter, a look at billings (revenue in the quarter plus change in sequential deferred revenues) is probably the better indicator of Okta's longer-term growth pipeline. As shown in the chart below, Okta saw its billings grow 67% y/y in the quarter to $104.8 million, setting the company up nicely for revenue beats in FY19:
Figure 2. Okta billings
Source: Okta investor relations
Note also that Okta's already-high gross margin climbed a further three points in the quarter to 71%, up from 68% in the prior year's Q4. With a high margin such as this, Okta's huge growth feeds the bottom line quite well.
As such, Okta also saw a huge improvement in its operating loss margins - driven not only by the advances in gross margin, but in efficiencies made in sales and marketing as well. GAAP operating loss in the quarter was -$25.3 million, translating to a -32% GAAP operating margin - versus -37% in the prior year's Q4.
On a pro forma earnings basis, which adds back stock comp and other non cash items to GAAP earnings figures and is the primary way analysts stack up Okta's performance against expectations, the company delivered pro forma EPS of -$0.10 against expectations of -$0.15, a fairly significant beat.
Perhaps even more important for investors to notice, however, is the fact that Okta broke even in its operating cash flows for the first time, hitting a tiny OCF of $0.2 million (but still better than the OCF loss of -$6.7 million in 4Q17). Given the robust trends seen this quarter, it's possible to see Okta enter breakeven cash flows in the current fiscal year.
Key takeaway: don't let the stock get ahead of the results
Despite all the buzz surrounding Okta's earnings, I'd argue that the stock's rally since its soft earnings release (as well as the 50% rise year to date) squarely put Okta in a position where it's fairly valued. Buying a growth stock at 11x forward revenues is a purely speculative play - there's no other way to put it.
There are, of course, positive catalysts for Okta going forward. Chief among them is the company's ability to turn a positive cash flow - if the company performs ahead of schedule on this front, investors could trigger a fresh wave of buying. However, the risks to the downside in my view are more plentiful. To date, Okta's growth has remained very stable in the untouchable ~60% range, starting into the first quarter of next year, Okta's guidance shows the beginnings of a growth decline.
Decay in growth rates is normal in fast-growing companies, and Okta is indeed usually conservative with its guidance, but investors can't ignore the fact that at a nosebleed valuation of 11x revenues, holders of the stock might react negatively to any whiff of deceleration, even if it's expected. And with no other basis for valuation (with cash flows still nascent and net income still deeply negative), Okta's stock could see risk in the near term.
Traders are likely to use this jump as an opportunity to take profits. If you're lucky enough to be holding Okta shares, I would do the same.
This article was written by
Analyst’s Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
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Comments (12)
The earnings gap. I think the stock will trade in a 5% range for a week or two then another leg up. OKTA is being recognized as THE identity leader.
For traders looking to peel off profits, I agree the stock has had a massive run. But I wouldn't try to time entry and exit points if this is a long term investment. Good luck all!!
