Is Tech Cyclical or Secular? Earnings From Nvidia vs. Snowflake; Diving Deeper Into Okta's Guide Down

In this Weekly Insights we provide thoughts the technology sector and earnings from key industrial technology companies: Nvidia, Marvell and Snowflake. We dive deeper into Okta's earnings, a leader in identity management, whose stock price has been under significant pressure. 

CONTENTS

Macro Backdrop: Is technology cyclical or secular? 

• Two elements drive industrial technology valuations (1) earnings (2) discount rates. What is priced in and what is not? 

Okta joining the "-70-80% Club"

• Guidance cut driven by integration challenges related to Auth0 acquisition. Valuation pulling back to all-time lows

IS TECHNOLOGY CYCLICAL OR SECULAR? 

We believe it is both. While technology adoption is a secular trend benefiting the companies under our coverage universe, there are many cyclical drivers that impact valuations and vary significantly from company to company. 

Valuations for technology are driven by 2 main factors (1) earnings and (2) discount rates. 

1. Earnings cyclicality is mainly a function of business model (e.g. hardware vs. software) and level of maturity. Companies that provide hardware, such as semiconductors face significant cyclicality in earnings as inventory management exacerbates weak demand (e.g. sell-in vs. sell-through). Conversely, software is sold on a subscription basis, and consequently software companies have steady earnings. Depending on the maturity levels, many may experience slower growth or elongates sales cycles.
   Similarly, themes and ideas that are in the early innings of adoption such as cloud infrastructure, are less dependent on the economy and will, consequently, have earnings that are less cyclical, compared to mature business models such CRM systems, e-commerce, gaming, may face more headwinds. 

2. Interest rates or "risk free" rate (e.g. 10Y Treasury) is a key valuation input. Consequently Fed stance on interest has been driving a lot of volatility in technology stocks. We estimate that on average a 1% move in interest rates results in ~15-20% downside for our coverage universe. However it is important to note that with the 10Y between 3-3.5%, an aggressive Fed has largely been priced into companies valuations. So as the 10Y has been fluctuating in this range, tech stocks have been forming valuation floors. We believe that the downside (if any) from here, will be largely driven by earnings. 

Not surprisingly, we are finding more earnings downside surprises in the cyclical areas of industrial tech (e.g. semis) and strong earnings from the more secular areas (e.g. cloud infrastructure): 

• Cyclical semiconductor stocks reported weak earnings including Nvidia (NVDA) and Marvell (MRVL). Both companies noted supply chain challenges. Earnings downside was exacerbated by inventory. Nvidia provided weak 3Q guidance with revenues expected to be down -17% yoy (-12% qoq), which was 15% below consensus, driven mainly by the gaming segment. Enterprise spending remained strong, but investors are now worried that this will be the next area of disappointment. 
   
• Secular cloud infrastructure. On the positive side Snowflake (SNOW)reported very strong result highlighting 83% revenue growth and guided to 67-68% revenue growth in F23. Customers that were underspending in the prior quarter are now outpacing expectations, demonstrating how un-discretionary enterprise spend is. EMEA was strong despite the fact that Europe is in a recession, highlighting the secular component of Snowflake's business. 

OKTA JOINED THE "-70-80% CLUB"

While there are many companies whose share prices have declined 80%, there are not many high quality companies that have experienced declines of this magnitude. Okta caught our attention as it is company that has been very well regarded by the Street (at least until recently) and just had a major execution mis-step.

As background, Okta has been a leader in workforce security (providing authentication for employees who need to access several applications) and the company had been expanding into CIAM (Customer Identity Access Management), essentially providing authentication for customers of companies. In March of 2021, Okta acquired Auth0, a leader in CIAM, for $6.5bn. While the product is similar at first sight, it is sold to completely different parts of an organization. The workforce security product is sold to CTOs and CIOs, and the CIAM product is sold to developers. Moreover, Okta had a competing product to Auth0 creating incremental confusion for its sales force and its customers. 

In light of the challenges, the company brought down its billings guidance, a forward looking indicator, to 27% from 35-36% implying a meaningful step down in growth. The ensuing price reaction was not completely surprising as 20% revenue growers trade at a significantly different multiple compares to 40% revenue growers. 

Post the sharp downside move, the market cap of Okta is <$10bn. While the synergies from the deal may now be at risk, investors who thought that $6.5bn was a fair deal for Auth0, can now acquire Okta + Auth0 for <$10bn. 

Another interesting datapoint is that Thoma Bravo, a well regarded PE firm, recently made two acquisitions in this space (SailPoint and Ping Identity) for total consideration of $9bn with combined ~$1bn of expected F23 revenues (compared to Okta's $2bn+ at ~the same enterprise value).

If Okta is able to re-accelerate growth, there would be meaningful upside both from earnings and, more importantly, multiple expansion.

Is it possible to re-accelerate growth?

The end-market for identity management is one of the more attractive areas within cybersecurity. The security management category is expected to grow at ~15% CAGR and identity, both workforce and customer (CIAM), are expected to outgrow the underlying end market. 

Okta has been a leader in the space with limited competition. While the chart below contains several players, it is important to note that each one has a very different value proposition (e.g. Okta is a leader in workforce protection, Microsoft works well for authenticating for Office 365, CyberArk is a leader in PAM (Privileged Access Management (PAM), and Auth0 (now part of Okta) is a leader in CIAM. 

Okta has identified a total addressable market (TAM) of $80bn based on number of potential users. This compares to the company's ~$2bn revenue base. While the market opportunity is clearly there, it remains to be seen if the company can get back on the execution track and capture it.

Okta Calculation Methodology: Workforce Identity and Identity Governance and Administration (IGA) TAM based on over 50,000 U.S. businesses with more than 250 employees (per 2019 U.S. Bureau of Labor Statistics) multiplied by 12-month ARR assuming adoption of all our current products and announced IGA products which implies a market of $21 billion domestically, then multiplied by two to account for international opportunity. Privileged Access Management (PAM) TAM based on internal estimates of Modern Infrastructure Access spend as a percent of Total Cloud Spend based on Gartner Forecast Analysis: Public Cloud Services, Worldwide report. $30B Customer Identity TAM based on 4.4 billion combined Facebook users and service employees worldwide multiplied by internal application usage and pricing assumptions.

Notes from the 2Q23 :

For more research and Cybersecurity Primer visit out website spear-invest.com.

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