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Profitless tech firms are having a bad year. Investors who didn't care about losses when rates were near zero seem to be changing their minds. Many of these stocks have lost more than half their value, but I believe there is further to go. Growth is now slowing, but profits (especially when considering stock compensation) are as elusive as ever.
Pegasystems (NASDAQ:PEGA) is an unprofitable company with single-digit revenue growth. On top of its fundamental challenges, the company is appealing a $2 billion judgment that a competitor won against it. I offer a fundamental valuation perspective on why the shares are overvalued no matter how the legal matter is settled.
Pegasystems is an enterprise software company that makes software for application development and digital process automation. According to its website, the company sells a "powerful low-code platform that builds agility into the world's leading organizations, so they can adapt to change." Clients use its "AI-powered decisioning and workflow automation to solve their most pressing business challenges." The architecture is "scalable and flexible." The company was founded in 1983 and has decades of experience in tailoring its offering to market needs. It is headquartered in Cambridge, MA.
The stock has woefully underperformed the market in the last year. The company has been unprofitable this year and in the prior four years.
For the latest quarter ending September 30, 2022 (or what the company headlined as "the best quarter of the year"), the company generated $270.7 million in revenue, up 6% YoY. Operating income was a loss of $77.2 million (-28.5% operating margin). This includes stock compensation, which I do not ignore, as I believe it is a real expense.
The company currently has 82 million shares and a market capitalization of $2.9 billion. It has $593 million of debt and $276 million of cash. It thus has an enterprise value of $3.2 billion, amounting to 2.7x its annual revenue.
Analysts expect the company to generate $1.26 billion in revenue this year and growing 10% next year. I would regard this growth estimate as optimistic, since the company's growth is currently in the mid-single digits. The consensus estimates for $0.10 of EPS this year and $0.57 next year ignore a substantial amount of stock compensation.
The company is shifting to a subscription-based model from selling licenses, and this move is largely complete. I see no evidence of an impending inflection in the growth rate, e.g., a growing deferred revenue balance.
Given the company's consistent losses, it is hard to determine its value. However, I am offering a scenario where it will make an attempt to drastically cut costs and become profitable. Assuming the company cuts a third of its costs and gets some leverage from growth, I am modeling a 6% GAAP operating margin in the long term.
A 6% margin on $1.26 billion of expected revenue this year would mean normalized annual operating profit of $$76 million. I would assume a 5% tax rate due to the company's net operating losses over the last few years that can shield taxes. Thus, the company would generate $72 million in after-tax operating income or $0.88 per share. I would apply a generous 25x multiple to arrive at a per share value of $22 for the business. Subtracting net debt of $4 per share on the balance sheet would result in fair value for the shares of $18. Thus, I believe there is a 50% downside from the current share price of $36. There are no meaningful comparables for the company, but a high-quality software company like Microsoft (MSFT) trades at 25x earnings.
In a bull case, the company will surprise to the upside with a 10% operating margin. This would result in a normalized annual operating profit of $126 million or $120 million after tax. I will apply a 30x multiple on the per share profit of $1.46 to come up with a value per share of $44 for the business. Subtracting net debt of $4 per share would result in fair value for the shares of $40. This would represent a 10% upside from the current share price.
I recommend that investors avoid PEGA stock, sell any existing positions or short the stock. The short interest is low at 5%. With a professional account, you can generate more than 3% a year on the proceeds from shorting the stock, from the short rebate that your broker will pay you. The rebate is generated by investing the sale proceeds in the overnight market (less the broker's fee).
The company was sued by a competitor, Appian (APPN), in the Circuit Court of Fairfax County, Virginia, alleging that Pegasystems had misappropriated Appian's trade secrets and violated the Virginia Computer Crimes Act. In May 2022, a jury found that this misappropriation was "willful and malicious," and awarded Appian damages of $2 billion. In September 2022, the court entered judgment in the amount of $2.06 billion, consisting of the jury award and attorney fees, with post-judgment interest accruing at 6% a year. The company is appealing this result, a process that could take years.
If the judgment is upheld, the consequences could be fatal to the company. It will most likely be able to deduct the payment as an expense against taxable income over time, so with a tax benefit at the 20% statutory rate (and ignoring the interest component), it would amount to $1.6 billion, a little more than the value of $1.5 billion I calculate for the company ($18 for each of the 82 million shares).
On its website, Pegasystems takes a more sanguine view of the situation, stating that it has the financial strength to pay the judgment. It points out that it raised $600 million in February 2020 with a convertible debt offering. My view is that raising $600 million in a placid business environment to retain the cash on one's balance sheet and fund one's business is one thing; raising $2 billion in the current tight-money economy without any profits to repay it, in order to pay it out to a competitor, would be virtually impossible.
The most likely scenario would be for the parties to settle the litigation for a lower amount, with Pegasystems issuing stock and some debt to fund it. A $1 billion settlement would be a loss in value of $10 per share, which would hurt, but would allow the company to continue with its business. It would also save the company the current $10 million or so it is spending on legal fees every quarter.
During the easy money boom time, many companies issued low-cost convertible debt, since it was almost free money for a period of time. PEGA's $600 million convertible costs it a mere 0.75% a year. The problem is that all debt eventually comes due, and the company needs to have the cash to repay it or roll over the debt. This convertible is due March 2025. It is unlikely to be converted into shares since the conversion price is $135 a share, increased to $196 with capped calls - a far cry from the current $36 share price.
Even without its legal issues, PEGA would find it hard to roll over the debt at such favorable terms. In fact, it is likely to face a "crush of competition" according to a accurate WSJ article about a company looking to get a head-start on dealing with its debt due in the same time frame. Investors are also likely to take a more hard-nosed view on lending money at low rates to unprofitable companies. So the company has a little more than two years to get to profitability and settle its litigation overhang. The clock is ticking!
Based on its quantitative analysis, Seeking Alpha helpfully provides a warning in red that PEGA is at high risk of performing badly. It has a composite rating of 1.47, equating to a strong sell, with an F for valuation and C- for profitability, offset by a surprising A for growth. As is usually the case, Wall Street analysts are more positive, with a rating of 3.3, representing a hold. Their price targets have been following the stock lower all year.
Shorting a stock has many risks. Rather than repeating them, please refer to one of my prior articles, for instance, the one on Guidewire (GWRE) or GitLab (GTLB). The only company-specific risk here is around the progression of the company's appeal of the Appian lawsuit verdict.
The company is paying a dividend of 3c per share every quarter, which represents a cost for short positions. Somewhat irresponsibly given its losses and net debt, it was also buying back its stock earlier in the year, although it did not in the most accurate quarter.
A position in PEGA is best avoided at the current price. Intrepid investors may short the stock in anticipation of the company's losses continuing and the chance that the company will have to pay to settle its legal problems.
Writing a short thesis on a stock on a public forum is an invitation for blowback from employees and holders of the stock. I welcome respectful comments from eponymous readers. If you are a holder or employee, you would be better off directing your energies towards having your company become profitable.
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“As we strive for continued success, I extend my deep gratitude to our recruitment partners, implementation partner TalentSprint and partner universities/colleges. The Pega University Program has proven to be extremely effective in creating certified, ready-to-deploy young software engineers,” said Deepak Visweswaraiah, vice president, platform engineering, and site managing director, Pegasystems, India.
“We have partnered with more than 24 global blue-chip companies to conduct exclusive placement drives, resulting in a consistent placement rate of over 80%. By the end of FY23, 10,000 students will have benefited from this program with great compensation growth and a tremendous impact on their careers. Our goal for 2023 is to place over 1,600 students. We aim to increase enrolment in Pega UAP by 20% next year and add three to four more universities to the program. In addition, we will prioritize talent and program quality while implementing Pega UAP India globally.”
Dr. Santanu Paul, Founder and CEO, TalentSprint, said “We are glad to have pioneered this initiative of creating industry-ready talent from select colleges with Pegasystems in India and the Pega University Program has been one of our most successful programs. The program holds a 95% certification rate with a high-touch placement assistance that has resulted in a balance between industry demands, student aspirations, and college objectives. The program has launched many careers across the globe and we look forward to many more."
The Pega ecosystem has created unlimited growth opportunities for students, college partners, and global blue-chip companies. Many doors open for program graduates as they are handpicked and trained thoroughly with 300+ hours of hands-on experiential learning by qualified and certified instructors. Their exposure to rigorous and cutting-edge industry practices offers them a significant career-edge over other students.
The Pega ecosystem ensures that the industry demand and talent supply are skillfully matched and offered to recruiters at no cost. College partners also benefit from the premium opportunity of getting their students nurtured with advanced tech skills, which leads to aspirational placements with leading companies in a highly competitive job market.
CAMBRIDGE, Mass., Nov. 21, 2022 /PRNewswire/ -- Pegasystems Inc. (NASDAQ: PEGA), the low-code platform provider that builds agility into the world's leading organizations, today announced that Ken Stillwell, COO and CFO, Pega, will present at the following upcoming investor conferences:
Archives of the presentations will be available from the Investors page of Pega's website for a limited time.
Pega is a powerful low-code platform that builds agility into the world's leading organizations so they can adapt to change. Clients use our AI-powered decisioning and workflow automation to solve their most pressing business challenges – from personalizing engagement to automating service to streamlining operations. Since 1983, we've built our scalable and flexible architecture to help people focus on what matters most, so they can meet today's customer demands while continuously transforming for tomorrow. For more information on Pegasystems (NASDAQ: PEGA), visit www.pega.com.
VP, Corporate Communications
VP, Corporate Development & Investor Relations
All trademarks are the property of their respective owners.
View original content to get multimedia:https://www.prnewswire.com/news-releases/pega-to-present-at-upcoming-investor-conferences-301684349.html
SOURCE Pegasystems Inc.
(Bloomberg) – Private equity firm Clayton Dubilier & Rice is in discussions to invest about $1 billion in enterprise software provider Pegasystems, according to people familiar with the matter.
The investment is strategic for CD&R and not a prelude to a takeover of Pegasystems, said one of the people, asking not to be identified because the matter is private. Terms aren’t finalized and the discussions could still fall apart.
Representatives for New York-based CD&R and Cambridge-based Pegasystems declined to comment.
Pegasystems rose 3.95 percent Tuesday to close at $36.56. The stock is down about 70 percent in the past year.
Founded by Chief Executive Officer Alan Trefler in 1983, the company sells software to Boost business processes, according to its website. It sells into large organizations such as Toronto-Dominion Bank, Aflac Inc., Cisco Systems Inc. and Banco Santander SA, its website showed.
Pegasystems has been embroiled in a trade-secrets lawsuit with Appian Corp. A judge in September upheld a jury’s earlier verdict against Pegasystems, which awarded Appian more than $2 billion in damages. Pegasystems is appealing and a decision is possible by the second half of 2023, according to Bloomberg Intelligence.
Even if Pegasystems is able to trim the amount, it would likely still rank among the largest-ever damages awards for trade secrets misappropriation, Bloomberg Intelligence litigation analyst Tamlin Bason wrote in September.
Representatives for New York-based CD&R and Cambridge, Massachusetts-based Pegasystems declined to comment.
Pegasystems Inc. (NASDAQ:PEGA) went up by 2.54% from its latest closing price compared to the accurate 1-year high of $119.04. The company’s stock price has collected -0.21% of loss in the last five trading sessions. Barron’s reported on 01/10/22 that Apple, Microsoft, and 13 More Tech Stocks to Help Investors Forget the Fed
Plus, the 36-month beta value for PEGA is at 1.03. Opinions of the stock are interesting as 3 analysts out of 14 who provided ratings for Pegasystems Inc. declared the stock was a “buy,” while 1 rated the stock as “overweight,” 9 rated it as “hold,” and 1 as “sell.”
We've set up an alert service to help smart investors take full advantage of the small cap stocks primed for big returns.
PEGA currently public float of 38.89M and currently shorts hold a 4.91% ratio of that float. Today, the average trading volume of PEGA was 453.66K shares.
PEGA stocks went down by -0.21% for the week, with a monthly jump of 12.52% and a quarterly performance of 1.11%, while its annual performance rate touched -67.97%. The volatility ratio for the week stands at 4.48% while the volatility levels for the past 30 days are set at 5.35% for Pegasystems Inc. The simple moving average for the period of the last 20 days is 6.06% for PEGA stocks with a simple moving average of -29.64% for the last 200 days.
Many brokerage firms have already submitted their reports for PEGA stocks, with Barclays repeating the rating for PEGA by listing it as a “Underweight.” The predicted price for PEGA in the upcoming period, according to Barclays is $25 based on the research report published on October 18th of the current year 2022.
Citigroup gave a rating of “Neutral” to PEGA, setting the target price at $39 in the report published on September 01st of the current year.
After a stumble in the market that brought PEGA to its low price for the period of the last 52 weeks, the company was unable to rebound, for now settling with -68.51% of loss for the given period.
Volatility was left at 5.35%, however, over the last 30 days, the volatility rate increased by 4.48%, as shares surge +12.79% for the moving average over the last 20 days. Over the last 50 days, in opposition, the stock is trading -6.16% lower at present.
During the last 5 trading sessions, PEGA fell by -0.21%, which changed the moving average for the period of 200-days by -61.90% in comparison to the 20-day moving average, which settled at $35.56. In addition, Pegasystems Inc. saw -66.47% in overturn over a single year, with a tendency to cut further losses.
Reports are indicating that there were more than several insider trading activities at PEGA starting from KOUNINIS EFSTATHIOS A, who sale 1,000 shares at the price of $39.85 back on Sep 09. After this action, KOUNINIS EFSTATHIOS A now owns 1,309 shares of Pegasystems Inc., valued at $39,850 using the latest closing price.
KOUNINIS EFSTATHIOS A, the VP of Finance & CAO of Pegasystems Inc., sale 500 shares at $41.50 during a trade that took place back on Aug 12, which means that KOUNINIS EFSTATHIOS A is holding 2,043 shares at $20,750 based on the most accurate closing price.
Equity return is now at value -163.50, with -30.00 for asset returns.