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Bull of the Day: Pegasystems (PEGA)

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Pegasystems (PEGA - Free Report) is a $5 billion provider of CRM and business process management (BPM) software that enable transaction-intensive organizations to manage a broad array of customer interactions. The company's customers represent a wide range of industries, including banking and financial services, insurance, healthcare management, and telecommunications.
 
I recently bought this mid-cap Software company, originally founded in 1983, because it's trading at just 5 times sales of $1 billion. And if it achieves 8.4% revenue growth this year to $966 million and 12.5% growth next year to $1.1 billion, it will be maintaining a 10.4% CAGR for sales over seven years.  
 
And after an earnings hiccup last year, estimates are rising again as analysts and the company get in sync on the growth trajectory and needed investments in marketing and sales. More on that challenge coming up.
 
Plus, the price chart has been basing in a high & tight flag between $62 and $66 since their strong Q4 report on Feb 20 that delivered top and bottom line beats and raised revenue guidance. And below I share the weekly chart which displays the all-time high close that came after that report and is threatening a bigger break-out to sustained new highs above $66.
 
First, let's review that earnings performance. PEGA gave investors something they really wanted to see: growth in ACV (average contract value). ACV of $570 million was up 23% year-over-year and term license and cloud ACV grew 40% yoy. 
 
This Q4 report represented a 5th consecutive quarter of strong results, as PEGA capitalizes on digital transformation initiatives in large enterprises and expands its cloud application offerings and capabilities. UnitedHealth (UNH - Free Report) , for instance, relies on PEGA to integrate artificial intelligence tools into their services and data analytics. 
 
On the conference call, Pegasystems CFO Ken Stillwell re-framed the company's 2022 targets for 15-17% yoy revenue growth and 23-25% EBITDA margin. As long as the company operates within their "Rule of 40" (margin + growth = 40%+), it prefers to swap margin for a higher growth rate.
 
Here's that weekly chart with a new bullish formation threatening a bigger move above 2-year resistance at $65-66...
 
 
Transformed for the Cloud
 
Pegasystems really began its transformation into the world of cloud computing software applications only 5 years after its giant competitor Salesforce (CRM - Free Report) went public. From Wikipedia...
 
In March 2010, Pegasystems acquired the enterprise software company Chordiant for around $161.5 million. The acquisition gave Pegasystems access to new markets such as online training, telecommunications and healthcare, with Pegasystems integrating Chordiant and its customer relationship management (CRM - Free Report) technology into its existing operations. Pega Cloud was introduced using Amazon Web Services in 2012, and in October 2013, Pegasystems acquired the mobile application developer Antenna Software for $27.7 million. Located in New Jersey, Antenna also had bases in Kraków and Bangalore.
 
Pegasystems hired a cloud technology proponent to develop its cloud technology strategy in 2014. Over the following year, Pegasystems invested in network operations in North America and India to support its cloud services. In May 2014, Pegasystems acquired the Bangalore-based MeshLabs, a text mining and analytics software startup. The Times of India reported that Pegasystems would integrate MeshLabs's text analytics software to "gather unstructured social media data and decode it into actionable business insights for its clients."
 
Marketing Strategy Transformed for the Future
 
Last week, Pegasystems CEO Alan Trefler was on Jim Cramer's MadMoney TV program on CNBC to talk about the company's years of being under the radar. The host recognized that the company's business process management is far ahead of the competition, but noted that many people aren't aware of the firm.
 
Trefler agreed, noting that his firm is "number one in real time interaction management and business process management" and that "to be trusted by Google speaks to the power of our software." He also highlighted that it's not a situation where a company chooses only CRM or PEGA because "we compliment Salesforce.com in many settings."
 
"I think therein lies the opportunity. For a lot of years we were very, very targeted in terms of who we offered our product to. We weren't very aggressive from a marketing point of view," Trefler told Cramer. "We didn't have close to the number of feet on the street that you need to really engage organizations deeply. We are massively changing that."
 
Wedbush Best Ideas List Adds PEGA
 
After the Feb report, Wedbush added PEGA to their Best Ideas List (less than 20 names) with an $84 price target. Analyst Steve Koenig described the business growth, challenges and the investment opportunity...
 
PEGA’s differentiation in strategic business application development and partnerships with large integrators is opening up large markets to PEGA (e.g. customer CRM applications). PEGA is currently going through a model transition toward more recurring sales. This shift has a negative impact on revenue optics in the near-term, but will likely be highly accretive to the company’s cash flow in the long-run.
 
PEGA’s sharp shift to the cloud looks to be on increasingly solid footing, which should drive double-digit revenue growth and FCF acceleration beginning in FY20, per our waterfall model. Although large-deal lumpiness is still a potential source of near-term volatility, PEGA’s growing revenue base and increasingly stable licensing mix—with cloud now at 50% of new business— should provide a somewhat smoother path forward.
 
The i-bank's Software analyst team also note PEGA’s 4.6x EV/CY20E revenue multiple as "attractive relative to peers" trading at 6X-7X. They expect continued ACV momentum in FY19 to provide the catalyst for a positive rerating by the market. The Wedbush team predicts that FCF-based valuation should come into focus as investors gain visibility as PEGA’s cloud transition accelerates cash flows in FY20 and beyond.
 
As Pegasystems invests in marketing to compete with the big cloud players, earnings will make a slow recovery. For me, the main metric to watch will be the sales growth -- and a break-out to new all-time highs above $68 won't hurt either. 
 
Disclosure: I own PEGA for the Zacks TAZR Trader portfolio.
 
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