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A Quick Take On Pegasystems
Pegasystems Inc. (NASDAQ:PEGA) reported its Q4 2022 financial results on February 15, 2022, beating revenue and EPS consensus estimates.
The firm provides workflow automation software and related services to enterprises worldwide.
I don’t see any major organic catalysts to the company's stock price, so I’m on Hold for PEGA in the near term.
Pegasystems Overview
Cambridge, Massachusetts-based Pegasystems was founded in 1983 and sells a variety of workflow automation software to major industry verticals.
The firm is headed by founder and CEO Alan Trefler, who is also founder of the Trefler Foundation.
The company’s primary offerings include the following:
Platform
Customer Decision Hub
Customer Service
Sales Automation
Client Lifecycle Management
Know Your Customer.
The firm acquires customers through its direct sales and marketing efforts as well as through partner referrals.
PEGA also operates a Marketplace, Partner Portal and Launchpad.
Pegasystems’s Market & Competition
According to a 2022 market research report by Verified Market Research, the global market for workflow automation was estimated at $8 billion in 2019 and is forecast to reach $39.5 billion by 2027.
This represents a forecast very high CAGR of 23.7% from 2020 to 2027.
The main drivers for this expected growth are demand from various major industry verticals for improved digital processes that can drive real-world product efficiencies, lower costs and increase sales volumes.
Also, the chart below shows the global workflow automation market growth outlook by the three main categories of solution:
Workflow Automation By Product Type (Verified Market Research)
Major competitive or other industry participants include:
IBM
Appian
Oracle
Software AG
Newgen
AURA
AgilePoint
Agiloft
Monday.com
Jira
Others.
Pegasystems Inc.’s Recent Financial Results
Total revenue by quarter has trended higher, although unevenly:
Total Revenue (Seeking Alpha)
Gross profit margin by quarter has produced uneven results:
Gross Profit Margin (Seeking Alpha)
Selling, G&A expenses as a percentage of total revenue by quarter have dropped in the most recent quarter:
Selling, G&A % Of Revenue (Seeking Alpha)
Operating income by quarter has turned positive in Q4 2022:
Operating Income (Seeking Alpha)
Earnings per share (Diluted) have fluctuated substantially in recent quarters:
Earnings Per Share (Seeking Alpha)
(All data in the above charts is GAAP.)
In the past 12 months, PEGA’s stock price has fallen 37.9% vs. that of Appian’s drop of 16.7%, as the chart indicates below:
52-Week Stock Price Comparison (Seeking Alpha)
As to its Q4 2022 financial results, total revenue rose 25.4% year-over-year, while gross profit margin increased by four percentage points.
Management did not disclose any retention rate metrics, only characterizing them as "high."
SG&A as a percentage of total revenue dropped and operating income rose well into positive territory.
Earnings per share were the second-highest positive result in the past nine quarters.
For the balance sheet, the firm ended the quarter and year with $297.2 million in cash, equivalents and short-term investments.
Over the trailing twelve months, free cash used was $13.1 million, of which capital expenditures accounted for $35.4 million. The company paid a very high $122.2 million in stock-based compensation in the last four quarters.
Valuation And Other Metrics For Pegasystems
Below is a table of relevant capitalization and valuation figures for the company:
Measure [TTM] | Amount |
Enterprise Value / Sales | 3.1 |
Enterprise Value / EBITDA | NM |
Price / Sales | 2.8 |
Revenue Growth Rate | 8.8% |
Net Income Margin | -26.2% |
GAAP EBITDA % | -5.2% |
Market Capitalization | $3,660,000,000 |
Enterprise Value | $4,050,000,000 |
Operating Cash Flow | $22,340,000 |
Earnings Per Share (Fully Diluted) | -$4.24 |
(Source - Seeking Alpha.)
As a reference, a relevant partial public comparable would be Appian Corporation (APPN); shown below is a comparison of their primary valuation metrics:
Metric [TTM] | Appian | Pegasystems | Variance |
Enterprise Value / Sales | 5.5 | 3.1 | -43.7% |
Revenue Growth Rate | 26.7% | 8.8% | -67.2% |
Net Income Margin | -32.3% | -26.2% | -18.7% |
Operating Cash Flow | -$106,550,000 | $22,340,000 | --% |
(Source - Seeking Alpha.)
The Rule of 40 is a software industry rule of thumb that says that as long as the combined revenue growth rate and EBITDA percentage rate equal or exceed 40%, the firm is on an acceptable growth/EBITDA trajectory.
Pegasystems Inc.’s most recent GAAP Rule of 40 calculation was only 3.5% as of Q4 2022, so the firm need significant improvement in this regard, per the table below:
Rule of 40 - GAAP | Calculation |
Recent Rev. Growth % | 8.8% |
GAAP EBITDA % | -5.2% |
Total | 3.5% |
(Source - Seeking Alpha.)
Future Prospects For Pegasystems
In its last earnings call (Source - Seeking Alpha), covering Q4 2022’s results, management highlighted the trend toward digital transformation as a driving force for customers and prospects alike, especially in the wake of the global pandemic.
Notably, IDC has projected that all application developers will be low-code or no-code developers by 2025.
However, earlier in 2023, management announced a 4% headcount reduction, with most of the cuts in its go-to-market organization.
Looking ahead, company leadership said it is ‘planning for more conservative growth in 2023.’ Management guided 2023 full-year ACV growth of 12% at the midpoint of the range.
Regarding valuation, the market is valuing PEGA at an EV/Sales multiple of around 3.1x.
The Meritech Capital Index of publicly held SaaS software companies showed an average forward EV/Revenue multiple of around 6.2x on February 23, 2023, as the chart shows here:
EV / Next 12 Months Revenue Index Multiple (Meritech Capital)
So, by comparison, Pegasystems Inc. is currently valued by the market at a discount to the broader Meritech Capital SaaS Index, at least as of February 23, 2023.
The primary risk to the company’s outlook is an increasingly likely macroeconomic slowdown, which may accelerate new customer discounting, produce slower sales cycles and reduce its revenue growth trajectory.
Management expects 2023 to be a more difficult year, in terms of growth and visibility.
As of now, I don’t see any major organic catalysts to the company's stock price, so I’m on Hold for Pegasystems Inc. in the near term.
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