PegaWorld 2019: Phoenix Rising

Last week, we attended PegaWorld 2019, Pegasystems’ (PEGA) annual customer conference, and the company’s Investor Day held in conjunction with the event. With over 5,000 attendees, the turnout was a record for Pega and emblematic of its growth to date and a still significant opportunity that lies ahead. When we first came across Pega over a decade ago, the company was considered the leader in the Business Process Management software market. Since then, Pega has expanded its capabilities and now goes to market with a no-code platform for digital transformation, Pega Infinity, enabling customers to build, extend, and deploy a broad range of enterprise applications for customer engagement and digital process automation. Considering Pega Infinity spans no-code/low-code applications, established markets like customer engagement/customer relationship management, and emerging opportunities in robotics process automation (RPA), management’s contention that Pega serves an enormous addressable market, estimated to reach $74 billion by 2023, appears plausible to us. Our conversations with customers, partners, and prospects in attendance at PegaWorld 2019 lend further credence to the massive opportunity ahead of the company as all highlighted numerous use cases for the platform with many of those not even considered prior to the event.

Pega’s transition to an as-a-service company began two years ago. With that shift, management sought to reduce the friction for customers to acquire and expand their usage of its platform. CEO Alan Trefler’s keynote reinforced this notion, emphasizing the ability for customers to rapidly build and deploy applications that deliver a quick return on investment, differentiating the advanced artificial intelligence and robotics automation capabilities part and parcel to Pega Infinity from those of competitors, and assuring customers that their investments in Pega are future-proof. We believe these factors are critical in convincing customers to embark on their digital transformation journeys with Pega. Given the pace at which technology is advancing and the complexity introduced by private, public, and hybrid cloud strategies, the knowledge that new innovation, such as the multi-channel messaging capabilities acquired via In The Chat, can be introduced into Pega Infinity and adopted without breaking existing applications should provide peace of mind to buyers. Pega also unveiled Project FNX (pronounced phoenix), a multi-year undertaking focused on developing software that writes software, thereby ensuring applications are automatically updated as new technologies become available. Project FNX, along with the more tangible introduction of the Enterprise Low-Code Factory to operationalize the deployment of low-code apps by any employee, also moves Pega into the realm of DevOps, another large market opportunity.

In early 2018, Pega took a major step in its transition to an as-a-service company with the decision to comp all sales on an annual contract value (ACV) basis. The land and expand approach typical of subscription-based software models plays well with Pega Infinity, which enables customers to start fast and ultimately move across an entire organization. For instance, an enterprise looking to leverage Pega’s capabilities in customer engagement could begin with a customer self-service application to process straightforward requests like a change of address and later introduce a personalized marketing application that takes a customer’s actions and location into account to deliver a personalized offer. Per management, the company has over 20% wallet share with only two or three customers in the Fortune 100 today, suggesting a significant opportunity for expansion. Moreover, only 500 customers or so have reached the threshold of spending $100,000 or more with the company. To build brand awareness and capture additional wallet share, Pega has been ramping investments in sales and marketing. Today, approximately half of the sales team has been with the company for less than two years, providing a runway for growth as productivity ramps. Early returns appear promising as evidenced by strong growth in ACV and Pega Cloud ACV in particular. Of note, we spoke with several organizations in attendance at PegaWorld that brought as many, if not more, prospects as users. These prospects were aware of successes that others within their companies had with Pega and could see a myriad of use cases for their own teams. One interesting use case that was mentioned a couple of times was utilizing Pega to ensure compliance with the California Consumer Privacy Act (CCPA), which goes into effect next year.

While customer engagement use cases seem most prevalent at present, we think the company’s RPA capabilities and the associated back office use cases also represent a meaningful growth opportunity. During the Investor Day session, management stated that competitors marketing RPA solutions have created a lot of noise and hype in the space but have struggled to deliver value to customers. Most offer only unattended bots built using open source solutions that include little to no proprietary technology. These unattended bots simply mimic the actions of humans to automate specific processes. Although Pega also supports unattended bots, the company has patented technology for attended bots that work in concert with employees on the desktop. The associated use cases are more complex and have the added benefit of increasing employee satisfaction as the bots typically handle the more mundane and repetitive aspects of an employee’s job. Management expects the market for attended bots to far exceed that of unattended bots. Interestingly, the company also offers a Workforce Intelligence solution that is capable of identifying processes ripe for robotics automation. As for the RPA adoption curve, we spoke with a large insurance customer that has already deployed 50 unattended bots using Pega and now plans to deploy its first attended bot. When asked about the potential for additional deployments of attended bots, we were told that the funding is there, but the primary bottleneck is in finding the internal resources to take on these projects. Another customer in the federal sector shared a similar anecdote, noting that a lack of personnel trained on Pega has posed challenges in its current implementation.

From a financial standpoint, Pega exited 2018 with ACV of $570 million, representing growth of 23% Y/Y. While not considered guidance, management indicated that simply sustaining that growth rate puts Pega on track to reach $1.3 billion in ACV by FY ’22. At that point, total revenue would approach $1.6 billion with approximately 70% from recurring sources, 25% from professional services, and the remaining 5% from perpetual licenses. As for margins, the company continues to target the “Rule of 40” in which the sum of its growth rate and free cash flow margin totals 40% or more. However, the aforementioned investments in sales and marketing along with revenue headwinds from the cloud transition will weigh on margins in 2019. In Q1, Pega again delivered strong growth in ACV, which increased 20% Y/Y and reached $591 million. A higher than anticipated mix of cloud bookings negatively impacted the reported top and bottom line results, a scenario which may well recur again as the company’s transition progresses. Regardless, we believe this phenomenon arising from license-to-cloud transitions is well understood by investors and all eyes will be on the company’s ACV growth and progress toward the Rule of 40. In terms of valuation, shares of PEGA currently trade at approximately 5.3x consensus revenue estimates for next year. Considering Salesforce (CRM) agreed to acquire Tableau Software (DATA) yesterday at 9.6x projected sales to play a greater role in its customers’ digital transformation initiatives and has previously named Pega as a potential M&A target, we think the stock is worth a closer look here.