After the successful MuleSoft IPO last week, the next high-growth candidate coming public is Okta, which styles itself as “the leading independent provider of identity for the enterprise.” Enterprise software bundling/pricing is often deliberately abstract, but happily the pricing page on Okta’s website lists the company’s five core product offerings and their pricing in an easy to digest way:
I won’t go through each product in detail, but to here’s what Okta does in a nutshell: it helps companies manage employee identities and it helps employees securely access applications. As SaaS applications proliferate, pain points have emerged for both key constituencies: employees have to repetitively log into various applications in web browsers, and employers have to struggle with the security ramifications of SaaS applications being available anywhere, anytime outside of the corporate network.
Okta solves these challenges by enabling companies to offer single sign-on (acronym: SSO) for their employees, allowing them to sign in just once and move seamlessly between SaaS applications. It also offers multi-factor authentication (acronym: MFA), which requires proof points of identity beyond just a password to more rigorously verify that an employee’s credentials have not been compromised. Okta has extended the product further by providing lifecycle management services for the provisioning and management of software subscriptions to help new employees get what they need quickly and make sure subscriptions are cancelled when the leave. Finally, it offers identity management services for other SaaS companies to incorporate into their own products.
This product enables a delightful user experience: Okta-powered employees can sign in just once and access a slew of enterprise apps. By using enabling MFA on top of this, companies can pull off a truly rare feat: making software simultaneously easier to use and more secure than before. Here’s a quick snip of the landing page a user sees once they’ve completed the initial login process to give a sense of what this looks like:
Grading the IPO:
To think through the factors that will drive the company’s IPO success and valuation, I’m going to score it on variables that matter to me as an investor, including the size of the addressable market, competitive positioning today, the long term competitive moat, the revenue churn dynamic, fundraising to date, growth efficiency and finally valuation in light of all the other factors. Some important factors are missing, including an evaluation of the management team and strategy going forward- without a chance to interview them 1x1 as I would have in my old role, I don't feel like I have enough information render a fair judgment on these. Each variable will get a score from one to ten, with ten being most desirable from an investment perspective:
Total addressable market (10/10) This is easy to approximate given the pricing information I showed earlier: Okta’s pricing today equates to $14/user/month at list prices, or $148/user/year, if a customer buys the full suite of products. Factoring in some discounting and the fact that full product penetration is a pipe dream, let’s go with $100/user/year as an approximation of the addressable market at today’s pricing. There are tens of millions of knowledge workers in the US alone who could potentially use Okta’s products, and as SaaS applications proliferate the need will become even more dire. It isn’t hard to imagine Okta having 50m global users one day, or $5bn of revenue using the assumptions above. Unless pricing in this category comes down (more on that in the competitive section) it is hard to argue that Okta will run out of growth opportunities anytime soon given that it is at a ~$200m revenue run-rate today.
Competitive position (7/10) Though the market is crowded, Okta stands out with a leadership position in the Gartner Magic Quadrant for Identity and Access Management and is widely recognized as a leading player in this space. There are many pure-play competitors (see the table below), but they generally either smaller or growth more slowly. There are also significant enterprise competitors, including Microsoft, Salesforce and IBM, of which Microsoft is the most competitive today. In all, Okta is a clear market leader, but strong alternatives exist and it is not “the” market leader in the way that some other leading SaaS companies are, so the score is 7/10.
Long term moat (5/10) This is my greatest area of concern for Okta, as the core user-facing product functionality today (SSO and MFA) is thinner than would be ideal for driving continued separation between the company and competition. The company will continue to launch innovative new solutions on top of the core product and there is a little network effect thanks to the pre-existing integrations, but a meaningful risk is that either a smaller competitor or a giant like Microsoft, Salesforce or Amazon(AMZN) successfully attacks the market with a competitive product paired with a bundling approach or a much lower price point. This is something potential investors will have to monitor very closely going forward and is sure to be a topic of conversation on the IPO roadshow. Microsoft, in particular, is a potential boogeyman here given its ability to leverage its Office365 franchise and deep enterprise relationships.
Churn dynamic (8/10) Churn is a major driver of a SaaS company’s ability to sustain rapid growth and show operating leverage. Okta has excellent reported churn metrics highlighted by a 120% dollar-based retention rate for the nine months ended October 31st, 2016, meaning upsells are more than offsetting churn by a wide margin. One major factor in Okta’s favor is that adoption is high as this is generally a mandatory product for employees to use and part of daily workflows. Another factor it that it is hard to see how end users might start auguring for a replacement: once you have a solution like this in place, it is hard to see what a competitor might offer that would make a switch worth the cost. Despite all of this, my score is just 8/10 as there are a few reasons for caution:
1. Okta is growing so fast that many customers have not even had a natural opportunity to churn yet, so dollar-based revenue retention will likely fall as growth inevitably slows.
2. The flip side of such a simple and easy to use product is that end user pain from switching to a competing solution is lower than ideal. As a result, IT departments may be more susceptible to cost-savings arguments from lower priced competitors in the long run.
Fundraising (10/10) Per Crunchbase, Okta has raised $228m to date from a set of great venture firms: A16Z, Sequoia and Greylock, with the last fundraising round in 2015 at a reported $1.2bn valuation. That may have been a bit aggressive at the time but the company has grown into it well and there are no signs that the existing shareholder base is likely to be disappointed by the outcome of the IPO. With elite backers and a reasonable level of capital raised so far for its size there isn’t much to dislike here: 10/10.
Growth efficiency (8/10) Okta is in a class of its own when it comes to both growth and losses. It grew gross profit almost 110% year over year in 2016 (note: this includes one quarter of my own estimates), while generating the largest negative free cash flow (measured as a % of revenue) of any company I follow that year. I view Okta’s losses as very reasonable for the ultra-high growth rate, though all else equal it is better when a company is cash flow breakeven and thus doesn’t run a risk of raising further dilutive capital. Still, with a recurring revenue model the company should show natural operating leverage as growth slows from unsustainably high levels: 8/10.
Valuation (too early to score) Without a price range or information about the size of the offering, it is too early to score how valuation measures up here. The last funding round (back in 2015) reportedly came at a $1.2bn valuation. We don’t know if that is exactly right, but I’ll use $1.2bn as an enterprise value as a point of comparison for charting purposes. The two charts below show my preferred valuation multiple (enterprise value / my 2017 gross profit estimate, acronym: EV/GP) against two different measures of growth/profitability:
Okta leaps out in the chart on the right because its gross margins increased dramatically in 2016, from 58% of revenue in 2015 to a projected 65%, as the gross margin of its services business improved dramatically and subscription gross margin also improved. This makes valuing it tricky: based on the chart on the left which uses revenue growth on the X axis, Okta looks like it could reasonably trade to 10x EV/GP. However, based on the chart on the right which uses gross profit growth instead, it could trade with companies like Shopify (SHOP), Twilio (TWLO) and MuleSoft with an EV/GP multiple in the low to mid-teens. Given the ultra-high growth rate and current market dynamic I suspect that Okta is set to earn a multiple closer to the latter group of high-flying companies when all is said and done, implying a post-IPO enterprise valuation just over $2bn, but again we need more details about the offering to have a firm view.
There’s no way to make a call on Okta as an investment without a price range but, like MuleSoft, it is a strong SaaS story with premium growth that should earn a premium multiple. Competition from players like Microsoft against the core product is my largest concern, while on most other variables it looks attractive. It will be fascinating to see the valuation the market awards Okta given the combination of unusually high losses and unusually high growth for a public SaaS company.
Here's a quick snapshot of the historical portion of my personal Okta model- any omitted data is not included in the S-1, to my knowledge.