Kindig on Okta

I got this article in my inbox today and thought it was worth sharing.…

It’s from Beth Kindig. She is a tech investing writer and has been talked about before on this board. She seems to be quite knowledgable regarding the technology side of things so I like(d) reading her (free) stuff.

Anyways, she argues in this piece that Okta is priced to perfection and criticizes large and increasing expenses. She sees OKTA as more of a momentum play and not a buy-and-hold, since she thinks the last two quarters (she is talking about Q12020 and Q42019) the company got weaker fundamentally.

Her argument that Okta is getting weaker fundamentally is based largely on the fact that they have increased their net losses more than revenue. Of course, if you see the numbers she is citing, she is talking about GAAP numbers. I thought that was a bit disappointing to see. As we have discussed many times on this board, if you count SBC as an expense (GAAP) but at the same time use the diluted share count (after SBC) for your EV/S calculation you are counting the effect of SBC double – that’s simply wrong.

Looking at Non-GAAP numbers, there is not much that worries me. Non-GAAP operating loss was down almost 50% yoy and 60% sequentially in Q2. Admittedly, Q1 was a quarter with unusually high losses (that’s what Kindig is criticizing probably) but as we saw this quarter things have come back to normal again. Thus, I would argue that Q1 was an outlier and shouldn’t be seen as a reversal of the trend towards Non-GAAP profitability.

Here is a look at Non-GAAP operating margin:

	   Q1	           Q2	           Q3	           Q4	        Full Year
2017	-53,13 %	-39,47 %	-32,56 %	-22,92 %	-35,40 %
2018	-36,54 %	-23,33 %	-28,36 %	-11,69 %	-23,83 %
2019	-13,16 %	-20,00 %	-6,16 %	         -4,24 %	-10,36 %
2020	-19,89 %	-7,05 %	        -11,46 % (guidance)

Can you see fundamentals weakening here? I see consistently improving margins.

Her other point in the article is that competition will be tough for Okta: "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.

(Of course, you could counter that argument by saying that Okta’s independence is a huge competitive advantage since customers can use them seamlessly across many different cloud providers.)

On the other hand, she does acknowledge that Okta has the superior product at the moment and that cloud infrastructure is a revenue segment that will determine the world’s most valuable company over the next few years. Then again, “Okta has an incredible feat ahead to remain more agile and to iterate faster than opponents that have bottomless amounts of cash.”

The bottomless amounts of cash argument has never really impressed me because it simply doesn’t play out in reality in my experience (at least not in capital-light businesses as software). I’m surprised that Kindig is using this rather lame argument.

Bottom line, I don’t think that Okta got fundamentally weaker in the last quarters, quite the contrary. Also, I can’t share competitive worries at the moment. Just look at the Gartner Magic Quadrant or The Forrester Wave – Okta seems to be so far ahead of competition… Valuation is obviously a bit of a problem, but that is a shared problem among all of our stocks at the moment. Higher valuation multiples mean less future returns, but I can still see a lot of upside here, even though the stock might take a little breather in the short-term because it has run up so much recently.