Progress Software: Off To A Good Start
- Progress Software delivered strong Q1 results with a revenue beat of $10M.
- The guidance for the full year is good, and the product updates are better than anticipated.
- Valuation remains conservative relative to the options to expand its platform.
Progress Software (NASDAQ:PRGS) is off to a good start in 2021. The Q1 beat and the encouraging guidance for profitability and cash flows have set a good tone for investors looking into the software company.
I am reiterating a price target of $60 as I expect the growing recurring revenue and new bets such as Chef to drive EBITDA in FY'21 and beyond.
I am bullish on PRGS's growth prospects due to the sustained growth momentum, encouraging forward growth guidance, options to drive long-term growth, and the huge market opportunity.
Progress Software Corporation develops business applications. The company operates through three segments: OpenEdge, Data Connectivity and Integration, and Application Development and Deployment.
Source: Seeking Alpha
Looking at the market opportunity, Progress is in the business of delivering business applications tools.
The software business model is known for growing/traveling far and fast.
The comments below from the market expansion opportunity provided by the acquisition of Chef validates this point.
It's worth spending a few moments talking about the DevOps market. Industry analysts forecast that the DevOps market will go from a little over $4 billion revenue in 2019 to nearly $15 billion in 2026, a CAGR of 19%
During the five-year period from 2014 to 2018, venture capitalists invested over $100 billion in nearly 16,000 companies in the infrastructure software market, and this fanatic pace continues to increase.
Source: Progress Software
With a positive conviction in the market opportunity, we can put more faith in the expanding growth indicators provided during the last earnings.
PGRS started CY'21 on a good note with Q1'21 revenue of $121.2M (+11% y/y). Progress Software noted that the revenue growth benefitted from the OpenEdge segment, which has historically been the largest contributor to revenue. Revenue also benefitted from Chef (under the application development and deployment segment), its most recent acquisition.
Progress introduced two new metrics: annual recurring revenue and net dollar retention rate.
Progress defined ARR (annual recurring revenue) as the annualized value of a related (maintenance and subscription contracts) at the end of a period. This secluded perpetual license revenue and non-recurring professional services revenue.
Progress defined net dollar retention as Beginning ARR, less churn and down sells, plus upgrades) divided by Beginning ARR.
PRGS noted that the dollar net retention rate was between 97% and 100%. This is a function of higher than anticipated renewals and improved relationships with some of its top customers.
Given the results, Progress was able to raise FY'21 guidance comfortably. The previous guidance was for revenue of between $513 million and $521 million, representing 12% to 14% growth over fiscal 2020. Now Progress expects FY'21 revenue of between $519 million and $527 million.
Operationally, we remain focused on operating our business efficiently, allowing us to generate best-in-class operating margins. We're confident that our total growth strategy in combination with this operating philosophy will provide substantial and sustainable value to all of our stakeholders.
Source: Progress Software
Progress has been around since 1981. The systems software market has witnessed some consolidation. Progress has also improved operations to the point where it now generates profits and cash from operations. This cash has helped fuel its M&A-driven growth strategy in recent quarters. Progress noted that it is still pursuing deals to ensure it continues to modernize its platform during the last earnings.
Source: Seeking Alpha
Despite these investments, Progress remains focused on operational discipline. Progress already earns an attractive grade of A- using SA's quant rating tool. This is a function of its enviable gross margin and the expanding income margin.
I expect the earnings to keep propelling free cash flow in line with the guidance for FY'21. Progress expects to end the current fiscal year with a free cash flow of $155M to $160M. This is in line with the LTM FCF trend, ensuring that PRGS can continue its cash allocation policies, including:
1. The y/y dividend (quarterly) raise to $0.175 per share.
2 The share buyback program which helps to offset potential EPS dilution from new stock issuance.
PRGS should see a boost to its liquidity profile to keep its leverage ratios in line should it need to raise more cash to fund future acquisitions.
Currently, the liquidity position consists mostly of cash, cash equivalents, and short-term investments of $114 million.
Source: Annual Report
This should be enough to cover the short-term contractual obligations. Readers will recall that PRGS has a debt position of $398M (mostly long-term) which consists of its secured term loan, which matures in 2024, and the drawn portion of its revolving line of credit. These debts were used to fund the acquisition of Ipswitch and Chef.
I am maintaining a fair value of approx. $60, which assumes a 5-Y revenue CAGR of 10%. This estimate correlates with analysts' bullish average price target of $56. This will benefit from strong uptake from Chef (DevSecOps).
I expect some of the growth to be inorganic. This will impact the cap structure and profitability ratios.
I also expect PRGS to maintain an EBITDA margin of 30%+ in line with the historical trend.
My FCF projections continue to assume an equity-led cap structure, a tax rate of 20%, modest yearly reinvestment (Capex/Sales), growth till perpetuity of 3.5% - 4.5%, and a discount rate of 8.5%-9.5%.
Source: Seeking Alpha
I expect the valuation to be supported by PRGS' factors such as growth, value, and profitability, which are better than most of its peers in the Systems Software industry.
Risks to the growth story include weak demand for PRGS' offerings, liquidity pull from new acquisitions, pressure from competitors, and a volatile macro environment.
PRGS's improved growth guidance is encouraging. The forward guidance for profitability and cash flows suggests it won't have much issue with its cash allocation programs. Progress Software has good valuation grades to attract both value and growth investors. In the absence of execution issues and a worsened macro environment, PRGS is expected to do well this year.
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