Imagine these two kinds of Okta (NASDAQ:OKTA) shareholders. You have Individual A, who bought OKTA stock at the end of 2018 when it was trading at $64, and then there is Individual B, who bought in at the end of July when it was trading at a 52-week and all-time high.
Individual A is sitting on a 56% return year to date through October 22. Individual B has managed to lose 30% in less than three months by buying at the inflated levels. At this point, Individual B would gladly take $142, breakeven and call it a day.
But there’s little question OKTA is bound for $188.71. Here’s Why.
OKTA Stock and the $188.71 Target
That number represents the conversion price of Okta’s $1 billion in convertible notes the company issued in September. Paying 0.125% in annual interest for the next six years, they mature on Sept. 1, 2025. Like all convertible notes, purchasers can convert them into OKTA stock anytime after Sept. 6, 2022.
Anyone who bought the Okta notes is betting that OKTA stock will be higher than $188.71 at some point over the next 36 months. That’s because a $1 million purchase of notes will pay $3,750 in total interest over the next three years, hardly a King’s ransom.
The same buyer of notes has the right to convert his or her $1 million investment into 5,299 shares of Okta stock. At its current share price, the stock’s worth approximately $526,148, well below the $127.94 price, the conversion rate was calculated.
At the time the notes were issued, the conversion rate was a 47.5% premium to its September 4, 2019, closing price. In seven weeks, that premium’s increased to 90.1%, making the convertible notes look like a pretty miserable deal.
How Does It Get to $188.71?
It continues to add customers and grow revenues at breakneck speed while figuring out how to cut its expenses.
In the first six months of fiscal 2020, Okta grew its revenue by 49.1% to $265.7 million. Unfortunately, it also increased its operating expenses by 51.7% and the cost of revenue by 41.3% in the first half of the year.
The company expects to generate between $560 million and $563 million in revenue in fiscal 2020 (a growth rate of 40.5% at the midpoint) with a non-GAAP operating loss between $62 million and $64 million for an operating margin of -11.2%.
To get to $188.71, investors will want to see the cybersecurity firm turn its negative operating margins positive. To do this, it’s got to reign in its operating expenses while maintaining or increasing its gross margins.
In the first six months of the year, Okta’s gross margin increased 150 basis points to 72.2%, while operating expenses, as a percentage of total revenue, increased 190 basis points to 108.1%.
The first part’s good. The second part, not so much. It’s got to do better. And soon.
The Bottom Line on OKTA Stock
The last time I wrote about Okta was in September. At the time, I felt OKTA stock, although overvalued, was worth holding onto because an insider (Khosla Ventures owns 6% of the votes and 1.1% of the company) continued to own its stock despite the fall from July highs.
OKTA was trading around $106 at the time. It’s continued to fall since then, although it appears to have stabilized in recent days.
As my InvestorPlace colleague, Jamie Johnson, recently stated, Okta’s growing its revenues and customers at a fantastic rate. Furthermore, it’s been hiring like crazy to keep up with the growth.
Those are all good things to bring to the table when wooing investors.
However, investors have become less patient in recent weeks about unicorns losing money. That unhappiness has manifested itself through lower share prices. Okta included.
To get to $188.71, Okta’s operating expenses as a percentage of total revenue will have to come down into the low 90s, or better still, the 80s, before I see it hitting the conversion rate on its convertible notes.
Could it happen in the calendar 2020? Maybe, but I’d be more inclined to bet that it will happen in 2021.
If this is a tax-advantaged account from which you’re investing Okta, I wouldn’t do it. Taxable accounts are a different story.
At the time of this writing Will Ashworth did not hold a position in any of the aforementioned securities.