Pegasystems

Moat: 2/5

Understandability: 4/5

Balance Sheet Health: 4/5

Pegasystems is a software company providing low-code platforms for building applications, with a focus on AI-powered decisioning and automation.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

Pegasystems (PEGA) is a software company primarily focused on providing a low-code platform to build business applications, specializing in AI-powered decisioning and automation. Their platform aims to help businesses streamline operations and improve customer engagement.

Business Overview

Revenue Distribution

Pegasystems’ revenue is primarily derived from its software subscriptions, which account for most of their revenue. Professional services related to implementation and usage of its software solutions add to this. A small portion comes from license and product sales, which are not a focus of the company. Recurring revenues represent a large portion of their overall business.

  • Subscription Revenue: Primarily from their Pega Cloud platform which provides recurring and predictable revenue streams.
  • Professional Services: Consulting, implementation, and training services for Pega’s clients add to the business model and make up a good portion of revenue.
  • License and Product Sales: A much smaller portion of revenue is generated from software licenses, not the focus of the company.

These figures will change with time and focus on the recurring subscription based model. The company is shifting from the old licensing revenue model to a recurring, more predictable, revenue system.

The industry is moving towards cloud-based solutions and low-code platforms that enable businesses to quickly build and deploy applications. AI and automation are also becoming very important for these businesses to compete in the industry.

  • Low-Code Platforms: Rapid growth due to the increasing demand for flexible and quick application development solutions.
  • AI and Automation: The use of AI to automate business processes is expected to become more and more important in the following years.
  • Cloud Computing: Moving to the cloud because of the benefits it offers like scalability, low costs, and ease of use.

Margins

Pegasystems’ margins have been fluctuating. While they have relatively high gross margins, they are struggling to achieve high operating margins, mainly due to their higher operating costs. They have shown consistent growth in subscription gross margins.

Competitive Landscape

The competitive landscape for PEGA is quite crowded with many competitors offering similar low-code platform solutions. Companies like Salesforce, ServiceNow, and Microsoft, amongst others, compete directly with PEGA in several fields. A key component of PEGA’s strategy should be product differentiation and how sustainable those offerings are.

  • Salesforce: Has a wide reach and a broad portfolio of cloud services including a development platform.
  • ServiceNow: Offers various SaaS solutions and strong work management solutions that could cause pressure on PEGA.
  • Microsoft: A big company with low-code tools under its Power Platform which could offer a bigger threat.

What Makes Pegasystems Different?

Pegasystems emphasizes the use of their AI-powered decisioning and automation capabilities. Unlike many low-code platforms, Pega has had a heavy focus on this, which they believe makes their platform unique and beneficial for companies that need more advanced business solutions. They also have a track record of focusing on large, complex enterprises.

Financials

Revenue

Pega’s revenue has seen fluctuation as the company is transitioning towards a subscription-based model. While the company is moving more to subscription based revenue, its revenue streams have not been very stable. It does appear though they have successfully been improving their subscriptions revenue while also trying to minimize their less recurring revenue streams.

Profitability

The company’s profitability has varied widely in recent years. Despite strong revenue growth, earnings and margins were not stable, and losses were incurred. Some major factors behind poor profitability include their high operating expenses and non recurring expenses, like restructuring charges. This may signal a company that is going through an important change but may not be an ideal investment in the short-term.

Cash Flow

Operating cash flows have improved significantly in recent years. This trend is quite positive for the company as it indicates strong operational performance. The ability to grow cash flow should be a priority for the management and analysts will be keeping an eye on its evolution.

Capital Structure

The company’s debt levels are moderate and manageable. However, they have had a history of taking on debt to purchase other companies. It is important to monitor this, especially when it comes to the management’s focus on acquisitions.

Moat Assessment: 2 / 5

Pegasystems’ has a narrow moat, because while they have some level of switching cost for their clients, it’s not very difficult for clients to switch to other platforms. They do have an extensive list of large Fortune 500 companies, a solid brand, and have been around for quite some time which provides them a slight competitive advantage. Other competitive advantages that are based on scale or cost advantages do not really apply to their business model. Their main moat comes from the switching costs of their enterprise clients, and the perceived complexity of moving from one system to another which creates a “sticky” environment. It remains important to keep a sharp eye on the industry and whether clients are actually locked in by the offerings or not.

  • Switching Costs: Their system integrates in the day-to-day operations of their customers, making switching costs relatively high. However, other low-code platforms are also making integration easier, therefore, they have a narrow moat because competitors can reach the same degree of switching cost integration in the future.
  • Intangible Assets: While their brand is established, they lack the kind of brand power that, for example, Coca-Cola or McDonald’s possess. They have a good track record with large enterprises.
  • Network Effect: Does not apply to PEGA because it’s not an interaction-based platform, instead a project based one.
  • Cost Advantages: Does not have much of a cost advantage. Their software is somewhat more expensive.

Risks to the Moat

  • Competition: Intense competition from other well-established players with great financial might, like Microsoft, Salesforce, and ServiceNow, may erode their existing moat.
  • Technology Changes: New and more advanced technology could challenge PEGA’s offerings.
  • Customer Concentration: Even though they have a diverse customer base, their biggest customers do represent a large portion of their revenue which could make them reliant on them and less flexible to changes.
  • Acquisition Risk: Their reliance on acquisitions to grow means they depend heavily on acquisitions that may destroy value.
  • Debt: Although manageable, it can still limit their flexibility.

Understandability: 4/5

Pegasystems’ business is easy to understand in general terms, the idea behind their low-code platform is simple enough to be explained in a few sentences. However, the complexities and nuances behind their AI and automation offerings makes it not so easy to understand. Therefore, while most investors will be able to grasp it at a surface level, the underlying technology and operations may require some expertise.

  • They provide software to big and small companies to create applications.
  • The software is subscription based.
  • They offer a variety of integrations and services, including AI powered decisions.

Balance Sheet Health: 4 / 5

Pegasystems’ balance sheet is generally healthy with a good amount of cash and liquid assets. Debt levels, while elevated from acquisitions, seem manageable, and there are not that many long-term obligations that could threaten their viability. However, a closer examination of their investments might be needed to ensure they are not overvalued.

  • Cash and Liquid Assets: A significant amount of liquidity.
  • Debt Level: Moderate debt level and manageable debt, although worth keeping an eye on to see how management handles it.
  • Long-Term Liabilities: Other than debt, their long-term liabilities aren’t high, indicating they should remain flexible and have a secure economic future.

Recent Concerns, Controversies, and Problems

Over the last few earnings reports, concerns have been made that the revenue growth has been slowing down a lot, and that profitability remains in question. There has also been some concerns over their large reliance on share based compensation. The management has indicated that they have been making changes to their expense structure and that they expect the company’s growth to remain steady for the foreseeable future.

They have indicated that AI implementation is going smoothly and they do have a very strong market position in the AI driven software market. They have also acknowledged their over-reliance on stock options to compensate employees, but have indicated changes in policy that will reduce this reliance in the future. A recent lawsuit by Appian, a competitor, has also been made which alleges the company used trade secrets to create their products. However, management seems to be taking this event lightly and believes they are going to prevail in court.

Investors must make their own mind whether these recent concerns and issues are going to have a long term impact on the company’s value.

Conclusion

Pegasystems is a software company in an extremely competitive market that tries to stand out through its emphasis on AI-driven applications and its low-code platform. However, its moat isn’t as strong as some of its peers, and there has been some concerns over the past few years regarding growth, margins and profitability. The company is financially stable, but relies on acquisitions, and has to make sure its current financial situation continues to improve in order for them to be considered a good investment for the long term.