Despite the rapid growth of Okta's (OKTA 1.34%) end market of access and identity management, investors have aggressively sold the stock so far this year. Unfortunately, things didn't get any better after the company released its earnings results for the second quarter of fiscal 2023, as investors dropped the stock by nearly 34%.
Here are three reasons Okta's stock imploded after the earnings results were released.
1. Fading profits while interest rates rise
The risk of investing in high-growth unprofitable companies rises dramatically when the Federal Reserve raises interest rates, as it becomes much more challenging for these companies to raise the capital they need to grow. As a result, investors, uncomfortable with increased risk, will often sell unprofitable companies once they believe the Federal Reserve plans to raise interest rates aggressively.
Okta's problems began once the Federal Reserve signaled its intentions to fight inflation with interest rate hikes at its Dec. 15, 2021, meeting. Since then, the stock has dropped nearly 71% -- a loss that was exacerbated by its high unprofitability.
The company's net income (a measure of profitability) began a significant downward trend in the middle of 2021, creating a nightmare scenario for Okta of shrinking profitability in a rising interest environment.
Investors should not expect a quick rebound in Okta's stock as long as interest rates rise. Additionally, the stock will fall further if its profitability continues to deteriorate.
2. Problem integrating the Auth0 acquisition
When Okta first completed its merger with Auth0 in May 2021, it looked like the perfect marriage. Okta was a leader in workforce identity solutions, and Auth0 was a leader in customer identity and access management (CIAM). Consequently, management believed that adding Auth0 as a complementary piece could establish Okta as the most dominant company in the identity and access management industry.
Image source: Okta.
Shortly after the acquisition, management optimistically released long-term growth projections for the combined company of $4 billion in revenue by the fiscal year 2026. However, the marriage between the two companies has gotten off to a rocky start, and its $4 billion revenue projection has recently been called into question, for two reasons.
First, the company was overly optimistic about how fast it could integrate both companies' sales teams, especially since the Okta and Auth0 marketing plans were radically different. Historically, Okta marketed to top management like the chief information officer and chief security officer. In contrast, Auth0 salespeople sold its product more directly to developer teams within a company. In the short term, building a new simplified marketing plan for salespeople that sells the right identity product to the right company has proven challenging. As a result, management has said that sales integration is the primary reason it might not meet its original revenue guidance for fiscal 2026.
The second reason the company is less confident in its original revenue projections is that the merged company is losing salespeople much faster than management wants, with most of the loss coming from former Auth0 salespeople leaving. Okta plans to stem these losses by improving the compensation structure and hiring new salespeople. However, investors should not expect quick fixes to this issue.
3. Okta's significant management changes
CEO Todd McKinnon announced on the company's Aug. 31 earnings call that Frederic Kerrest, the executive vice chairman and chief operating officer, who also co-founded Okta, is taking a one-year sabbatical beginning Nov. 1. Kerrest will remain on the board during his leave, but McKinnon did not explain how the company planned to replace his COO position.
Then in a one-two punch, McKinnon said that Chief Product Officer Diya Jolly is leaving the company -- notable because she is responsible for helping align Okta's product teams with its new sales strategy. The company plans on splitting Jolly's role between two people. In the future, one person will run a product strategy for the customer identity cloud and another for the workforce identity cloud.
Of course, the market disliked these two key executives leaving during a critical period for the company.
Should you buy the stock?
If you are looking for a solid long-term opportunity, Okta has a long runway for growth. It had generated revenue of $1.6 billion on a trailing 12-month basis at the end of July 2022. Consequently, in a total addressable market of $55 billion, it has only penetrated 2.9% of its market. Additionally, the company is still rapidly growing revenue, with revenue growth of 43% year over year as of the second quarter of fiscal 2023.
The ride could be bumpy in the short term. Therefore, impatient or risk-averse investors are best off avoiding this stock as long as the Federal Reserve is raising interest rates.
