Progress Software
Moat: 3/5
Understandability: 3/5
Balance Sheet Health: 4/5
Progress Software is a software company providing products for the development, deployment, and management of high-impact business applications.
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.
Progress Software, with a history dating back to 1981, operates in the information technology space. They provide software products that cater to application development, deployment, and management. Their solutions are often used for building complex, enterprise-level applications, particularly those that connect to operational databases and systems.
The business’s revenue is primarily generated by recurring revenue sources like subscription and term licenses, alongside less predictable (but still recurring) maintenance and service revenues. Most of their products are distributed through a partner sales model rather than direct customer relationships, with most of the revenue coming from North America. In recent periods, Progress has also grown in Europe, Middle East, and Africa (EMEA) and the Asia Pacific regions. The company has over 2,200 employees globally, including over 700 at the R&D department and nearly 1000 customer support professionals. This distribution strategy is designed to ensure that its product and service can reach more customers without additional direct sales cost.
Moat Analysis:
Progress Software has a narrow moat, as described below, and can be considered to be a 3 out of 5.
Switching Costs: The main source of Progress’s competitive strength comes from the high switching costs their products create. Once a customer has built their business applications on Progress’s platform, replacing it is very difficult and costly. The level of effort to change systems, data migration, rewriting code, and employee retraining are significant impediments that would make it difficult for customers to move away to alternative providers. Established Products: Progress Software’s core products like OpenEdge and DataDirect Connect have long been used by customers and have good market recognition in their particular niche. While they don’t hold large parts of the market they have established a strong standing with many big customers and are very hard to be overthrown by new entrants.
Mistaken Moats
It’s important to recognize what are NOT a moat. While the company is often praised for their customer base, market share, and management expertise, they do not form a reliable moat on their own. A change in customer perception can drastically change sales, market share can be taken by new entrants, even very talented management teams can see their strategies being outpaced by new technologies. Therefore, the focus will remain on intangible assets, switching costs, network effects, and cost advantages.
Risks To The Moat And Business
While Progress has established a fairly reliable position, it faces a number of risks that could erode the company’s moat:
Technology Changes: Progress operates in the technology space, which is known for its fast changes. The demand for faster data transfer speeds, new software that is easier to use, and new programming languages can challenge the platform’s competitive edge if it does not adapt to these changes and innovate. In the most recent earnings call, management spoke of the company’s focus on “low code/no code” solutions, acknowledging the need to keep up with advancements in this field. Competitive Pressure: While the barriers to entry may be large, they are not insurmountable. The software industry is fiercely competitive, with numerous companies constantly trying to create more efficient systems. Progress needs to continue to compete effectively or risk losing market share to companies that offer higher performance solutions. Acquisition Risk: Progress’s reliance on acquisitions for growth exposes it to integration risks, especially since they have been focused on acquiring businesses and then implementing cross-selling strategies. They also acquire smaller companies, which do not always show high enough ROICs and they might be a distraction to the core business. Subscription Model: The company transitioned to subscription in the recent years. While this is good for stability, it may also lower revenue growth. If they fail to get new customers that can pay for the subscription model, the revenue growth will be impacted and it will take time to turn that around. The market also might view the business more as a service company rather than a software company which could be unfavorable.
Business Resilience
Progress Software has some strengths that improve the company’s resilience:
Recurring Revenue: A substantial portion of its revenue is recurring, giving predictability to cash flows even with uncertainty. Diversified Customer Base: Though most of their revenue is generated in North America, they do have customers all around the world, and the company is also present in different business segments, which reduces the risk of reliance on one geographic area or sector. Cost Controls: The company appears to be committed to managing operating costs efficiently, as evidenced by their stated focus on cost control and increasing profitability. Strong balance sheet: The company has low debt levels which means they are less vulnerable to financial distress.
Detailed Business Explanation
Revenue Distribution: Progress generates revenue through software licenses, subscriptions, maintenance and service. A bulk of revenue comes from subscriptions and term licenses, however maintenance and services are still a sizeable portion of the revenues. Geographically, North America remains the most important region for the company, but their revenues are also spread through the EMEA and APAC regions. Industry Trends: The IT industry is driven by new technologies, automation, and analytics. Companies are focused on having platforms that are scalable, are easy to use, and have interoperability with other systems. They need to be able to deploy a solution and bring business value rapidly without many problems. Margins: Progress Software has a high gross profit margin, typically between 80 and 90 percent. That’s expected with software companies. However, this profit margin drops down when operating expenses are factored in, but the company is still fairly profitable. Their main goal has been to increase profitability and margins over time. Competitive Landscape: The company is in a highly competitive market space with numerous players. They compete with major established companies as well as smaller upstarts in the application development, data connectivity, and security spaces. The competition is highly fragmented in their space. What Makes The Company Different? What makes Progress different is their long history of providing software solutions, deep domain expertise, and ability to provide robust and reliable platforms. They also have a very strong partnership ecosystem.
Recent Concerns / Controversies: There’s a recent worry about their acquisition of MarkLogic, which was acquired for a relatively high price of $337.5 million. Investors are wondering whether that acquisition will bring enough value to justify that price. Also, this is one of their most major acquisitions and the integration of this business will be carefully scrutinized, especially since their past acquisition performance has not been as good. The main argument the management brought up for this acquisition was the possibility of cross-selling into different clients. Progress has made a major transition to the subscription model. So, the company’s growth might be limited in the short term. The company also has been consistently buying back shares, so that is another point of discussion for the management. They have been questioned about their debt, and the large amount of cash holdings that may be better used for acquisitions. Management has also been questioned about the level of insider selling.
Financials In-Depth
The company has had a revenue growth of ~10% YoY. They had adjusted EPS growth of over 10%. The company has very high gross profit margins, typically in the 80-90% range and good operating profit margins (low 30%), which show the profitability of their operations. In the last five quarters (including guidance), they have consistently beat Wall Street expectations. This is also a highly cash-generative business, with high operating cash flows and free cash flows. They have low levels of debt, which limits their risk of distress. The company has repurchased ~300M dollars of its shares this year (fiscal 2023). They expect to continue that program. The long-term business goal is to grow recurring revenues, which they have successfully achieved over the past few years. There are multiple catalysts for the growth of the company in the long run. The company is expecting positive EPS growth and growth of over 8% in revenues for fiscal 2024.
Understandability: 3 / 5
The business is fairly understandable, given its nature as a software company that creates products for other businesses to build on top. However, it can be a bit complex to understand the specific nature of all their software products and how they help their clients. The various metrics that are used to value software businesses also can add to the complexity, especially when trying to model out the company’s performance for valuation.
Balance Sheet Health: 4 / 5
The balance sheet is fairly healthy with very low debt levels. They do not have any immediate liquidity concerns. However, they do have a very high cash balance which might be an indicator of a company that might be lacking in growth opportunities. At the current levels of debt, they have ample flexibility.
Summary:
Progress Software is a fairly stable business that has a narrow moat, with good recurring revenue, low debt, and strong financial position. They also have an experienced management team which is doing well at their job. However, the company also faces risks from the rapidly changing technology space and intense competition. Their core business is still dependent on existing products, and they have not yet clearly demonstrated that their acquisition strategy will create a lot of shareholder value over time. Therefore, if the company wants to grow, it is essential that they properly utilize their cash on hand to do value accretive acquisitions.