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Our investment thesis for Okta and Geely

Asia Analytica
Asia Analytica • 8 min read
Our investment thesis for Okta and Geely
Many of our investments are based on what we believe are secular trends that will drive sales and earnings over the longer term.
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Stocks saw a bit of a pullback last week, after chalking up strong gains at the start of the new year. This is perhaps unsurprising. Expectations have risen significantly on the back of better prospects for 2021. We suspect a fair amount of potential good news has been priced into stocks. It is, therefore, likely we may see more volatility, if and when reality fails to meet the lofty expectations. And with the start of the US quarterly reporting season, there will be opportunities for disappointment. That said, we remain upbeat on the outlook for further gains and are keeping our Global Portfolio near fully invested.

Many of our investments are made based on what we believe are secular trends that will drive sales and earnings over the longer term. One such trend is the migration to cloud, which has been accelerated by the Covid-19 pandemic.

While businesses have been severely affected by the pandemic, many have quickly learnt to adapt and cope, including through remote work and digitisation — and the cloud is a prime medium for these.

Global spending on cloud computing is forecast to register multiple years of double-digit growth. According to market intelligence, worldwide end-user spending on public cloud services is forecast to grow at a rate of 18.4% in 2021. Globally, we will see a shift in allocations for enterprise IT spending, where cloud as a percentage of total budget is projected to grow from 9.1% in 2020 to 14.2% in 2024. Cybersecurity is expected to be a top priority too.

Okta provides Software as a Service (SaaS) to enterprises, and is focused on identity and access management services. With enterprises moving more of their software and applications to the cloud, Okta’s identity management platform helps keep them secure by enabling authorised connections to the various cloud services via a single password anywhere and anytime.

We like that the company’s business model is centred on making processes both more efficient and convenient, which is the main purpose of having cloud services. There is a network effect, which reflects the increasing value of each new user to all existing users, as it integrates more customers to more critical services. Okta’s platform is agnostic and highly scalable. Customer and partner (a variety of cloud services and IT infrastructure providers) count has been growing at a steady double-digit pace.

Okta’s business has also moved from transactions or one-off contracts to subscriptions — stable, recurring revenue now accounts for 95% of total revenue, which implies a large safety margin for future earnings.

It is expanding its clientele list to larger enterprises — the number of customers with a contract value of more than US$100,000 ($132,570) is about 2½ times that of two to three years ago — including in the financial and public sectors. These customers now account for the bulk of its annual contract values.

Financial-wise, it is generating positive operating cash flow and free cash flow. Cash and equivalents is sufficient to cover total liabilities. Although the company is still loss-making, we think this is fine because companies in this space need to spend a significant amount on sales and marketing as well as research and development (R&D) for the business to grow and develop a brand name. In fact, Okta’s gross margin has been trending higher on the back of rising sales (see Chart).

Cloud adoption is still in the nascent stage. The company’s total addressable market is huge, estimated at US$55 billion currently. To put it in perspective, this is almost 80 times its year-to-date revenue, underscoring much room for growth. Okta forecasts its revenue will expand at a compound annual growth rate of 30% to 35% through 2024.

Its business has also demonstrated stickiness, with customers buying additional services instead of terminating them. Case in point: Its trailing 12 months dollar-based net retention rate has been averaging 120% over the past 10 quarters. For instance, the company is marketing its new customer identity solutions to existing clients, to complement its core workforce identity management services.

Clean energy and environmental, social and governance investing is another secular trend that will play out over the foreseeable future. The electric vehicle (EV) space, in particular, has gained significant momentum in terms of investor interest. And China is leading the world in terms of EV production and sales.

China aims to reduce greenhouse gas emissions to reach carbon neutrality by 2060. A key part of its master plan is the transition from the less energy-efficient internal combustion engine to hybrid and new-energy vehicles, mainly EVs. It intends to phase out conventional gasoline-fuelled vehicles by 2035. What China sets as ambition, it has almost always succeeded.

There is strong government backing and support for the production and purchase of EVs in the country, including subsidies for producers and consumers. We see Geely Automobile Holdings as one of the biggest beneficiaries of this broader shift to greener vehicles, as well as from recovering auto sales post-pandemic, underpinned by five new models this year and a better cost structure. The company is listed in Hong Kong and plans to list in Shanghai.

Geely’s overall strategy has been to strengthen its market positioning through partnerships and collaborations that span the entire supply chain.

One of its biggest acquisitions was Swedish-based Volvo Cars in 2010. Given the saturation of local budget brands in the domestic market, the strength of the Volvo brand name allows Geely to more effectively tap the premium, upmarket segment, which also has higher margins. Volvo has ambitious targets to be an electric-only brand by 2030; all new models, starting 2019, will be hybrids or full EVs.

The pending full merger of the two companies will reduce R&D expenses through technology-platform sharing, production and materials-parts procurement costs as well as a better reach in terms of raising funds in the global capital market, all of which are key to sustaining longer-term profitability amid intensifying competition in the electric and autonomous vehicles market. That said, Geely intends to preserve its existing brand identities, including upmarket brands Lynk & Co and Polestar — cars designed by Volvo and manufactured in China.

The company has partnered with leading battery producer, Contemporary Amperex Technology Co, to produce and develop vehicle batteries. The venture will reduce pressure on margins — given that battery costs make up a significant proportion of an EV’s total cost — as well as ensure a stable supply of lithium batteries for its own use.

More recently, Geely announced a tie-up with Baidu that focuses on intelligent EVs, in a competitive landscape with the likes of tech-savvy Tesla and NIO. Baidu’s autonomous driving platform, Apollo, will combine with Geely’s experience in car design and manufacturing to develop smart EVs. It is also teaming up with Tencent Holdings to work on areas “in the fields of digitalisation, intelligent cockpits, autonomous drive and low carbon development”.

In the latest development, the company entered into a joint venture with Taiwan-based Foxconn Technology Group, aimed at offering customised consulting and OEM production services to the global auto industry based on electrification, connectivity and autonomous driving technologies.

Geely’s management forecasts a healthy 16% year-on-year growth in total sales volume this year to 1.53 million vehicles, supported by short-term catalysts such as new model releases and longer-term catalysts such as strategic tie-ups with major players along the value chain. The company is in a healthy financial position, with a net cash and current ratio of more than 1. The stock has performed very well since we added it to the Global Portfolio in mid-December 2020, up 46.5%.

The Global Portfolio fared better than the benchmark index in the week ended Jan 20, gaining 2.8% and lifting total returns to 57.3% since inception. This portfolio is outperforming the MSCI World Net Return index, which is up 38.8% over the same period.

The notable gainers last week were Taiwan Manufacturing Semiconductor Co (+9.6%), Alphabet (+7.6%) and Builders FirstSource (+7.4%). On the other hand, Bank of America (-3.3%), Walt Disney (-1.4%), Singapore Airlines (-0.6%) and Adobe (-0.5%) were the four losers in our portfolio.

Disclaimer: This is a personal portfolio for information purposes only and does not constitute a recommendation or solicitation or expression of views to influence readers to buy/sell stocks, including the particular stocks mentioned herein. It does not take into account an individual investor’s particular financial situation, investment objectives, investment horizon, risk profile and/or risk preference. Our shareholders, directors and employees may have positions in or may be materially interested in any of the stocks. We may also have or have had dealings with or may provide or have provided content services to the companies mentioned in the reports.

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