By Beth Kindig
Okta, a San Francisco-based identity and access management company, is fundamentally weaker than many analysts believe, making its booming stock priced to perfection.
The company was early out of the gate for cloud-subscription IPOs in 2017, and the valuation has reaped the benefits of Wall Street’s enthusiasm for subscription models. However, a reasonable price to initiate Okta as a buy-and-hold investment is now in the rearview mirror, rendering it a momentum play. That will be important for investors when they review its earnings report for the three months through July after the stock market closes Wednesday.
Okta’s stock /zigman2/quotes/210420951/composite OKTA +1.34% dropped 10% on weakening guidance for both revenue and earnings per share (EPS) in the March earnings report. The stock quickly recovered, as there was little adjustment given for lower EPS guidance.
Investors put that out of their mind, as the stock recovered with renewed momentum within a few days and has not looked back. Last quarter, Okta raised its guidance to expected losses of $0.45 to $0.49 per share, although this “improvement” is relative, as the original expectations of the full-year loss was at $0.22 per share prior to the March earnings report.
Valuation has been an ongoing worry with Okta, as the company has the highest forward price-to-sales in its category, at 27, with a current price-to-sales of 34. Compare this to Workday /zigman2/quotes/201157610/composite WDAY +3.53% at 12 forward price-to-sales, Veeva Systems (which is profitable) /zigman2/quotes/202850210/composite VEEV +2.33% at 22, and Twilio /zigman2/quotes/205796518/composite TWLO +1.48% at 15.
There is ample evidence that, although Okta is priced to perfection, it does not need to report perfection to continue its momentum. This is one red flag for a buy-and-hold strategy at current prices, but a positive sign for momentum trading. Eventually, the market will want perfection for the price it’s paying when macro conditions warrant more discernment.
For instance, many analysts are touting the stock for positive free cash flow (FCF), although this is from operating cash efficiencies. Okta does not have positive free cash flow from positive net income, which is something financial analysts are writing out of the script entirely.
Free cash flow becomes more indicative of financial health when net income is positive; to separate the two underweights profitability, which is a mistake for buy-and-hold investors (or analysts) when evaluating the stock. Free cash flow positive is much more celebratory when net income is positive.
In fact, Okta suffered a record net loss in the fiscal first quarter that ended in April. Okta’s loss widened nearly 200% year-over-year, to $51.9 million. This led to diluted EPS of negative 46 cents, compared with negative 25 cents in the year-earlier quarter.
Lastly, Okta is no longer a debt-free company and is carrying $275 million in convertible senior notes.
Wall Street is laser-focused on Okta’s top line, and is a little blind-sided to the bottom line as free cash flow and subscription growth were the only touted highlights from last quarter’s earnings report .
Okta posted 53% year-over-year growth in subscription services to $108.5 million, while professional services revenue grew 15% to $7 million. Total calculated billings hit $158.9 million, with trailing 12-month subscriptions jumping 55% to $488.2 million.
The increase in net losses from the most recent quarter was under-reported due to subscriptions driving revenue growth of 50% year-over-year.
In the upcoming earnings report, the bar for revenue is set to less than 40%, which is an easy hurdle for a subscription cloud company that has been posting 50%-plus revenue growth for many consecutive quarters.