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By Tony Baer

We’d be the first to admit our surprise that Pegasystems (NASDAQ:PEGA) has thrived as well as it has. Our initial impression of the company about four to five years ago was of an interesting, rather eccentric bunch whose absent-minded professors had great ideas but little business savvy. At the time, the company was marginally profitable.

Maybe their professors weren’t that absent-minded and their approach not so pedantic after all, as the company has been on a winning streak for the past 10 quarters, scoring 25 percent growth last year as the rest of the economy (and software industry) tanked.

Tilting against windmills, the company scored big gains among established clients across financial services industries, who used Pega’s process “solution frameworks” covering areas such as loan origination and underwriting, wholesale banking, and retail bank account opening.

Pegasystems is on the right side of history, having embraced vertical frameworks. That’s an approach that you also find IBM taking. In business for roughly 25 years, Pega’s sales didn’t take off until it began rolling out a series of templates or frameworks that provided a 60 percent solution, eliminating the need to model commodity processes from scratch.

Either way, Pega’s success belies our observation that vertical templates are the future of enterprise applications — using the framework as a raw template, they will be composed from existing applications and data sources rather than written or implemented as a packaged application from scratch.

Growth last year added $35 million to the company’s cash cushion, leaving it with a nice healthy $200 million in the bank. But cash in a consolidating industry is trash when your rivals are either acquiring or getting acquired left and right. As so the question was, What would Pega do with its cash?

We have the answer

We now have the answer: Pega announced Monday its intent to acquire Chordiant, whose specialty is dissecting, analyzing, and optimizing a company’s experiences with its customers. The deal, at $167 million in cash, actually nets out to about $116 million when you factor Chordiant’s $51 million cash position.

Pega’s solicited offer trumped an abortive unsolicited $105 million offer back in January from CDC, an aspiring Hong Kong-based enterprise applications provider. Chordiant has come down a few notches over time, with business flattening to $75 million last year, down from $115 million a couple years ago. Pega’s $5 per share bid is about 10 percent of the company’s 2000 dot com peak, but a 30 percent premium over its current valuation.

Pega got a good deal, and Wall St. agreed, as shares of both companies rose on the heels of the announcement. It reflects the fact that Chordiant provides Pega two opportunities: 1) Deepen its presence in financial services accounts by going into the front office, and 2) gain a new beachhead in telecom where it currently has but a single critical mass client. Although telco could broaden Pega’s addressable market, the deal wouldn’t work if the solutions weren’t complementary.

Pegasystems offers a highly sophisticated, rules-driven approach to defining, modeling, and executing business processes. It offers roughly 30 industry specific templates, and well over a dozen cross-industry frameworks such as customer process management, control and compliance, procurement and so on.

By contrast, Chordiant covers what it calls “customer experience management,” which tracks customer interactions and offers predictive analytics for optimizing cross-selling, upselling, or customer retention strategies, or for predicting risk or churn. It also offers vertical templates for financial services, healthcare, and telecom. Chordiant’s predictive analytics have adaptive capabilities where the rules can change based on trends in customer response; if a promotion offer proves not as attractive as initially forecast, the rules can adjust the algorithm to reflect reality.

The potential synergy is where Chordiant optimizes customer-facing front office processes while Pega’s BPM frameworks optimize the corresponding back office processes such as loan origination.

On paper, it looks like yin and yan. But there are basic architectural differences between the products, as decision management consultant and author James Taylor has pointed out. Keep in mind that Taylor has traditionally been skeptical of Pega’s approach to embedding rules inside its process engine, rather than loosely coupling the two.

But he makes valid points that Chordiant handles rules differently from Pega, that the potential synergy between the two is great, but that the company need to take care that technical differences do not “derail the technical integration or cause the merged company to merge its operations without merging its products.”

So on paper, Pega has made a sound deal. As the company is not yet experienced in digesting acquisitions of this size, its success in consummating the Chordiant acquisition will become a predictive indicator of the company’s ability to survive and grow in a consolidating market where it will be expected to make more such deals.

This guest post comes courtesy of Tony Baer’s OnStrategies blog. Tony is a senior analyst at Ovum.

Author's disclosure: none.

Source: Pegasystems Doubles Down on Winning Streak with Chordiant Buy