We Continue to View Okta as a Leader in the Identity Space

Equity Analyst

Malik Ahmed Khan

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We believe Okta is poised for long-term success as a leader in the identity and access management, or IAM, space. Okta’s Identity Cloud, which weaves together the firm’s workforce and customer offerings, stands to grow in importance to its clients as zero-trust security infrastructures, digital transformations, and cloud migrations increase the company’s value proposition. However, we assign Okta with a no-moat rating as we don’t foresee excess returns on capital in the next few years. Yet, we believe the firm’s platform, impressive number of integrations, and a broad range of SKUs have allowed the business to be on the cusp of generating high customer switching costs and a network effect.

Okta targets two markets through its workforce identity and customer identity offerings. Okta’s workforce offerings enable a company’s employees to securely access its cloud-based and on-premises resources. The firm’s customer offerings allow its clients’ customers to securely access the client’s applications, such as a shopping cart on a website. We project continued demand for Okta’s products as the shift to zero-trust security infrastructures and digital transformations continue unabated.

While the IAM space remains competitive, we think Okta’s strategy of investing heavily in its sales and research divisions is sound. In doing so, the firm can maximize its value to its customers that it can land and subsequently expand.

Along with Okta swiftly increasing its customer base, the firm has also increased its enterprise penetration by landing larger clients, which are often stickier than smaller ones. We also believe larger clients provide Okta with more avenues to upsell as their digital resources are far greater in quantum than their smaller counterparts. Finally, we think that while Okta has made inroads with large enterprises in the U.S., the firm has attractive growth opportunities with large enterprises in the international markets.

Business Strategy & Outlook

We believe Okta merits a no-moat rating as the company’s hefty spending on sales and marketing (as evidenced by operating losses in recent years) will likely prevent the company from generating excess returns on invested capital over the next 10 years. We think that Okta’s underlying business benefits from high customer switching costs associated with its products and a network effect associated with the firm's integration network. The company also boasts strong dollar-based retention metrics and impressive customer growth. However, as a nascent business that transformed a bit via the acquisition of Auth0, we still think it will take a few years before Okta can generate economic profits in order to warrant a narrow moat rating.

Clients can leverage Okta's identity-based security platform, or Okta Identity Cloud, in workforce identity and customer identity. Okta has specific modules within these two verticals that span security, IT efficiency, workforce management, and customer experience.

To accurately contextualize Okta's eminence in the identity and access management, or IAM, space, it is vital to highlight the dissipation of the traditional security perimeter. As workflows and workforces have moved from onsite to a hybrid environment, the traditional security model of a secure perimeter has become increasingly obsolete. Instead, the hybrid-cloud and hybrid-work environments have pushed identity-based security as a means of enabling access to workflows and applications. Whether it is applications an employee needs access to or APIs an engineer wishes to run, an identity-based security approach verifies the individual's identity, their level of access, and then either allows or prevents entry. With digital transformations, cloud migrations, and the adoption of zero-trust security architectures only projected to increase, we view these secular trends as major tailwinds propelling the IAM space forward.

Okta's main claim to fame has been its workforce identity and access management, or WIAM, offerings. Put simply, Okta's WIAM modules allow its clients' workforces to connect securely to their employers' resources. As aforementioned, over the last several years, we have seen more workflow instances moving to the cloud and an increasing number of employees working remotely (even if for only a day or two a week). The COVID-19 pandemic accelerated both of these trends, with digital transformations, cloud migrations, and hybrid work environments all gaining prominence since the beginning of the pandemic. The obvious issue arising from increased cloud adoption and remote work is a marked increase in the number of attack vectors nefarious players can utilize while targeting companies. Okta's WIAM offerings seek to reduce these attack vectors by providing a layer between individuals (employees in this case) and the company's resources. These resources, which can be either cloud-based or onsite, can virtually take any form, including applications, APIs, storage, et cetera. Besides providing a security layer, Okta's WIAM offerings also include modules that increase IT efficiency by automating account creation, resource access, and lifecycle management.

When considering Okta's WIAM offerings, we think that high customer switching costs are likely. Across our coverage, we see that enterprise security spend is sticky. We believe security-related IT decisions are driven by security analysts and engineers, not accountants. Put another way, we do not believe companies nickel and dime their way to picking security vendors, especially in the IAM space. Customers that adopt security solutions do so to take uncertainty off the table—switching vendors often brings uncertainty back into play. When considering WIAM, there is a risk in changing vendors with the possibility of unauthorized access being granted or authorized access being revoked. This risk is a genuine concern for firms using Okta to manage access to mission-critical and sensitive resources. While competitors may offer a parallel migration that allows these concerns to be somewhat allayed, we do not see companies switching away from Okta due to the risk of exposing critical data to nefarious actors.

When looking at Okta's WIAM offerings in specific, it is hard to ignore the firm's Okta Integration Network, or OIN. With over 7,000 integrations, ranging from hyperscalers to software application providers, OIN allows Okta's clients to securely access resources critical to their workflows in a secure, seamless manner. We believe this extensive network further aids Okta's switching costs, as its clients could lose critical vendor integrations if they switch away from Okta.

We also think that OIN can help lay the groundwork for a network effects moat source around Okta’s business in the future. As more vendors integrate into OIN, these integrations improve Okta’s value proposition to its customers. This improvement, in turn, leads to Okta being able to sell its Identity Cloud to more users (that are more eager to onboard an IAM vendor with integrations that provide seamless access to resources needed by its workforce). As Okta’s customer count continues to grow, more vendors may be integrated with Okta, allowing their applications to be more easily deployed by end users. Both the vendors’ willingness to integrate more resources and the clients’ preference for an IAM vendor with more integrations creates a network effect.

With the acquisition of Auth0, Okta staked a more significant claim in the burgeoning customer identity and access management, or CIAM, space. While Okta had CIAM offerings before it acquired Auth0, the acquiree's organization was far more ingrained in CIAM than Okta's. CIAM, in its essence, is a double-pronged space that not only focuses on providing customers secure access to a company's resources but also allows companies to have more visibility into their customers (a method of increasing sales efficiency). While CIAM is an up-and-coming market, we believe the potential for this space is massive. As we look at the future of business-to-consumer, or B2C, interactions, we expect an increasing number of these interactions to be digital. From a business perspective, it is increasingly important to enable secure onboarding and verification of customers. Okta's CIAM offering also allows businesses to maintain a universal directory of all clients, an essential resource for sales teams in particular.

In a digitized world, customers expect their transactions with businesses to be secure and frictionless. We believe Okta's CIAM offerings allow for these expectations to be met. Much like WIAM, clients are unlikely to switch away from a CIAM vendor as switching away from an established vendor can carry a heavy price, including lost customer data. 

We believe another critical aspect of Okta's competitive strength is its neutrality. We believe that in a hybrid multi-cloud environment, enterprises are increasingly averse to vendor lock-in. Big software companies such as Amazon, Microsoft, and Google have long utilized the strategy of entering tangential verticals as a means of calcifying customer switching costs.

In the IAM space, in particular, Microsoft is a strong competitor. While competing against Microsoft in any subspace is far from desirable, we believe Okta's vendor neutrality gives it a competitive edge. When an enterprise uses Microsoft's IAM offerings, we expect it to be more beholden to using Microsoft across its organization. Over time, as an enterprise uses more Microsoft offerings, we expect to see a monopsonic dynamic emerge. Leaders across organizations have already begun to take note and have increased their adoption of multi-cloud strategies. Okta's IAM offerings, on the other hand, are source-neutral—allowing the firm to capture customers seeking to avoid vendor lock-in.

As mentioned above, we believe that both WIAM and CIAM verticals are conducive to high customer switching costs. As Okta lands and expands customers, its entrenchment in the client's security infrastructure deepens, leading to high switching costs. Further, the longer a customer sticks with Okta, we believe there are upselling/cross-selling opportunities that Okta can benefit from. These additional module sales are reflected in Okta's strong net retention rate, which is north of 120%.

Overall, we think the firm is still in early innings in terms of customer penetration and product adoption. We view this low penetration as providing Okta with a long runway for growth. We view both WIAM and CIAM spaces as largely greenfield, with many companies implementing in-house solutions that are expensive and unscalable over the long run. As a result, we believe Okta can land larger clients without having to displace well-entrenched IAM vendors.

That said, Okta has hefty sales and marketing expenses to capture these customers and is generating substantial operating losses in the meantime. These losses will prevent Okta from generating excess returns on capital in the near term and preclude us from assigning an economic moat rating to the firm.

None

Economic Moat

Okta

Okta, Inc. engages in the provision of an identity management platform for enterprises. It operates through the United States and International geographical segments. The firm's products include single sign-on, multi-factor authentication, API access management, authentication, user management, and lifecycle management. The company was founded by Todd McKinnon and J. Frederic Kerrest in 2009 and is headquartered in San Francisco, CA.

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