Okta-Auth0 Deal: A $6.5 Billion Analysis

A Significant Acquisition in the Identity Management Landscape

The recent announcement of Okta’s $6.5 billion acquisition of Auth0 has sparked considerable discussion. The sum represents a significant investment for one identity and access management (IAM) firm to make in another comparable organization.

Ultimately, this transaction unites two companies that approach identity management from distinct perspectives within the market. This convergence has the potential to establish a powerful synergy in the realm of digital identity.

Okta's Core Functionality

Okta primarily provides identity and access management (IAM) solutions to enterprises. These solutions enable single-sign-on access for employees to a diverse range of cloud-based services.

Examples of these services include popular platforms like Gmail, Salesforce, Slack, and Workday, streamlining user access and enhancing security.

Auth0's Developer-Focused Approach

In contrast, Auth0 functions as a developer tool, offering coders simplified API access to single-sign-on capabilities.

Developers can integrate IAM functionality into their applications with minimal code, avoiding the complexities of building such systems from scratch. This is analogous to the value provided by Twilio in communications or Stripe in payment processing.

The Understated Importance of IAM

While identity and access management may not be a glamorous field, it is undeniably crucial. This necessity likely contributes to the substantial financial activity surrounding it.

As Auth0 co-founder and CEO Eugenio Pace noted in 2019, authentication is often overlooked, despite being a fundamental requirement for all digital interactions.

A Comprehensive IAM Solution

The combination of Okta and Auth0 creates a remarkably complete IAM solution, spanning both backend and frontend functionalities.

This analysis will explore the significance of this deal within the broader identity market and assess whether the considerable investment made by Okta was justified by the acquisition of Auth0.

Identifying and Accessing Systems: A Critical Overview

Identity and Access Management (IAM) centers around verifying user identities and ensuring authorized access to applications. This process forms a foundational element of any organization’s overall security posture.

Recent market analysis by Gartner indicates a substantial valuation for the IAM sector, reaching $12 billion in the previous year, with forecasts projecting growth exceeding $13.5 billion in 2021. For context, Okta concluded its fiscal year 2021 with revenue surpassing $800 million. Auth0, meanwhile, is anticipated to finalize the current year with $200 million in annual recurring revenue.

making sense of the $6.5b okta-auth0 deal

Gartner’s November 2020 Magic Quadrant report identified Ping Identity, Microsoft, and Okta as leading players in the IAM market, listed in that order. Auth0 was recognized by Gartner as a significant challenger within the same market analysis.

According to Michael Kelley, a Gartner analyst, the acquisition represents a mutually beneficial scenario for both Okta and Auth0.

Kelley explained to TechCrunch that Okta possesses considerable marketing reach and widespread adoption, advantages not readily available to smaller vendors like Auth0. Okta is consistently included in initial discussions with clients regarding IAM solutions. Auth0 will immediately gain recognition through association with the larger Okta brand, and Okta will, in turn, enhance its credibility in engagements with developer-centric buyers.

Todd McKinnon, co-founder and CEO of Okta, expressed enthusiasm for the deal due to the complementary nature of the two companies’ approaches to identity management. He stated that the interaction developers have with an IAM service, and the level of flexibility they require, differs from the needs of a Chief Information Officer. Providing customers with choice and comprehensive support is a compelling advantage.

Auth0 offers a streamlined method for developers to integrate IAM capabilities. This developer focus was a key factor that attracted Sunil Nagaraj, managing partner at Ubiquity Ventures, who was previously at Bessemer Venture Partners during their 2014 seed investment in Auth0. At that time, API tools were beginning to gain prominence among developers. Twilio was still prior to its IPO, and venture capital interest in developer-focused companies was limited.

“I co-authored ‘10 Laws of Investing in Developer Tools startups’ in 2013. Building a startup specifically targeting developers, rather than IT purchasers, was still considered unconventional. These laws emphasized pay-per-use pricing, handling complex tasks developers prefer to avoid (like payments and authorization), and fostering genuine developer enthusiasm, as developers readily promote tools they value. I observed all these elements during my initial meeting with the Auth0 founding team,” Nagaraj noted.

Nagaraj believes this acquisition validates the viability of developer-focused businesses and suggests that this market is still in its early stages. The central question now is whether the market remains as undeveloped as Nagaraj proposes. If it does, Okta’s investment positions the company to capitalize on the potential for future growth.

A Deeper Examination

Despite the optimistic analyses and favorable statements from leadership, an alternative viewpoint deserves consideration. Many investors did not react positively to the announcement of the transaction. Following the news, Okta’s stock price experienced a decline – although it’s difficult to determine how much of this drop was attributable to the deal versus the company’s earnings – ultimately closing the next trading day down approximately 5%.

Is Okta’s valuation of Auth0 justified? This question prompted further investigation. Determining a fair price for Auth0, and comparing it to the $6.5 billion Okta plans to pay, is crucial to understanding the market’s reaction.

Okta has not integrated Auth0’s projected revenue into its own financial forecasts. This separation allows for a clear assessment of Okta’s figures and insights into Auth0’s size, enabling a potential market valuation for both entities.

Let's begin by assessing Auth0’s individual value. According to McKinnon during the earnings call, the company is projected to achieve an ARR exceeding $200 million in the timeframe aligning with calendar year 2021, representing approximately 50% growth.

We can establish a valuation range for Auth0 by comparing it to similar companies with comparable growth rates and revenue multiples. According to the Bessmer cloud index, Cloudflare and DocuSign exhibit growth rates similar to Auth0 and currently have valuations of 31.4x and 21.3x their forward revenue, respectively. This metric is suitable as we are considering Auth0’s end-of-year ARR.

Considering the valuation range of Cloudflare and DocuSign, Auth0 could potentially command a 20x to 30x forward-revenue multiple if it were publicly traded. With $200 million in ARR, this would equate to a valuation between $4 billion and $6 billion. While this is a broad range, it indicates that Okta’s offer price isn’t unreasonable.

The fact that Okta’s payment exceeds Auth0’s potential standalone valuation isn’t unexpected. Acquisitions typically involve a premium. The Salesforce acquisition of Slack serves as a prime example. Therefore, the $6.5 billion price tag aligning with our estimates is not surprising.

A Year-Ahead Financial Outlook

Let's project forward to the next year. Assuming Auth0's revenue expansion decelerates to 40% during calendar year 2022 – roughly corresponding to Okta’s fiscal 2023 – its Annual Recurring Revenue (ARR) could potentially reach $280 million. At this level of scale, the current acquisition price paid by Okta for Auth0 becomes demonstrably justifiable.

It’s conceivable that Okta’s initial investment exceeded Auth0’s present valuation. However, with a few additional quarters of sustained growth, the overall transaction can be viewed as quite sensible.

Okta is fundamentally acquiring an accelerated growth trajectory. The company anticipates growth between 30% and 31% in the present quarter, and between 29% and 30% for its current fiscal year (fiscal 2022, aligning with calendar 2021). Conversely, Auth0 is experiencing growth around 50%, with some variation.

Therefore, Okta isn’t simply acquiring a substantial revenue stream; it’s integrating a segment of top-line revenue that is expanding at a rate exceeding that of its core business. Considering an estimated $150 million in GAAP revenue for Auth0 this year, Okta’s total revenue surpasses $1.2 billion, compared to its previous projection of $1.08 billion to $1.09 billion. This represents a significant increase.

Applying its current enterprise multiple of 27.3x to forward revenue, a larger and more rapidly expanding Okta could potentially achieve a higher valuation once investors have fully processed the acquisition and it is finalized. While this isn’t guaranteed, several factors contribute to a more favorable perception of the deal than initially suggested by its price relative to Okta’s market capitalization.

The Focus on Developers

Okta has demonstrated success independently, however, developer-focused sales strategies are gaining traction due to their capacity for reduced customer acquisition costs (CAC). Should Auth0 deliver a lower CAC to Okta, the parent company could benefit from decreased blended acquisition expenses, alongside its increased growth and expanded scale.

Conversely, if Auth0's growth fails to meet expectations, the justifications previously offered for Okta’s acquisition price could be invalidated, potentially revealing the deal to be costly. Okta is placing a significant wager on the continued and rapid success of its new acquisition.

A failure to perform would validate the initial concerns of investors who questioned the acquisition’s price point.

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