Pegasystems

We are discontinuing analyst coverage of Pegasystems.

We will discontinue analyst coverage of Pegasystems on or about Sept. 11. We provide analyst research and ratings on over 1,500 companies globally and periodically adjust our coverage according to investor interest and staffing.

Our fair value estimate for Pegasystems is $40 per share, which implies a fiscal 2026 enterprise value/sales multiple of 3 times and a 5% free cash flow yield. Pegasystems achieved GAAP profitability in 2023 as its model transition finished. We forecast continued growth with expanding GAAP and non-GAAP margins as the firm achieves increased operating leverage for its core business operations.

We expect the company’s cloud migration to continue driving results over the next several years as existing customers migrate to the cloud. We model total revenue growing at a compounded annual rate of 5% over the next five years, with the mix shifting to cloud from all other revenue sources. We think investments in both the portfolio of solutions and the sales organization will pay off. We also believe the company will benefit from cross-selling CRM and BPM solutions to customers not already using both.

The firm’s model transition put pressure on margins, and prevented a clear picture of financial performance. As with the transitions at other software companies, margin compression was painful but is now over. We see non-GAAP operating margin expanding from 24% (actual) in 2025 to the upper 20% area by 2030. We expect leverage on all operating expense lines, as well as cost of goods sold, to contribute to margin expansion during this period.

We assign Pegasystems a no-moat rating. We believe the company benefits from high customer switching costs, and we have had Pegasystems as a narrow moat company in the past. However, the firm’s model transition was messy and elongated, which weighed meaningfully on returns, and then was punctuated by a massive legal award that initially broke against the company. The legal issue has since been resolved in the company’s favor, but uneven quarterly performance and artificial intelligence uncertainty have prevented us from formally reconsidering our rating.

Customer switching costs are frequently associated with software companies, which we see as consistent with Pegasystems. One of the main factors driving switching costs is the direct time and expense of implementing a new software package while maintaining the existing platform. A large portion of Pegasystems’ customers are enterprise-size, and a major implementation is likely to involve a system integrator and can take several years. Additionally, there are indirect costs along those same lines, mainly lost productivity as customers move up a learning curve on the new system along with the distraction of users involved in the function where the change is occurring. Lastly, and perhaps most importantly, there is the operational risk, including loss of data during the changeover, project execution, and potential operational disruption. The more critical the function and the more touchpoints across an organization a software vendor has, the higher the switching costs will be.

The recent history of poor adjusted returns on invested capital can largely be explained with Pegasystems’ model transition. Beginning in 2017, management changed the business model from a predominantly perpetual license to software as a service, to avoid large quarterly swings in revenue and offer customers the cloud-based delivery users prefer. The transition artificially damped revenue as well as margins, while increasing research and development expenses in tandem as Pegasystems had to port its products to the cloud. While the transition was messy, with a conclusion pushed out several times, we view the journey as being largely over.

While the engineering and financial impacts were challenging, we view the transition as a requirement for a modern software provider, especially as Pegasystems seeks to remain a leader in BPM and compete against its larger rivals. With the transition largely complete, we return a keen eye to its ability to grow annual contract value, which can face significant headwinds in periods of macro uncertainty when budgets are more highly scrutinized. This factor particularly pertains to Pegasystems, as it has one of the higher price points in the market. Even with existing customers, the firm may struggle to drive meaningful contract expansion with existing customers.

Pegasystems operates in two categories of software: customer relationship management and business process management. Its CRM solutions include marketing, customer services, and sales automation. Its low-code BPM solutions include robotic automation and case management software designed to work across multiple applications to create workflow connectivity. Both markets are broad and growing and feature a wide range of ever-increasing competitors. Management believes the company’s total addressable market is approximately $60 billion-$70 billion and will grow to over $100 billion in the coming years. For comparison, Pegasystems has posted revenue of north of $1 billion since fiscal 2020. While an opportunity this large implies a significant growth runway, we do not see the company’s growth materially outstripping the expansion of the underlying markets based on well-established competition.

Pegasystems’ foundation comes from BPM solutions that were adopted by enterprise customers for case management in customer service applications. American Express was an early adopter of its software to automate processes in contact centers, such as providing the same user experience regardless of how the customer engages with the company, notifying supervisors automatically if approval is needed for raising a credit limit, populating all data fields, and alerting all necessary areas of the business when a new customer has been onboarded, among many other actions. Such seemingly simple and critical tasks may have initiated dozens of business processes across a variety of systems and were likely to even have involved the use of hard copies at one point.

In subsequent years, Pegasystems has transformed into a low- or no-code application development platform. Key to Pegasystems’ software is that the solutions are conducted by the employee who is directly involved with the business process and controls the workflow automation, as opposed to an IT professional. The no-code platform enables the employee in charge of the workflow to drag and drop interfaces from a comprehensive library of existing code blocks to establish a set of rules for a specific process. Over the years, automation capabilities have been increasingly incorporated into modern business applications.

In CRM, the largest competition is from Salesforce and Microsoft, followed by other notable players such as Oracle, SAP, and ServiceNow, among others. While the BPM market has been flourishing since its inception and we expect it to continue to grow more than 10% annually, we believe CRM is the smaller opportunity for Pegasystems, as many applications have built in automation functionality for specific functions, such as customer relationship management, human resources, and marketing. There is significant overlap in the CRM and BPM landscape with competition from Microsoft, Salesforce, Oracle, ServiceNow, Atlassian, and others.

The company has long been a leader in BPM, where use cases are now proliferating to increase productivity and lower costs.

Pegasystems has a differentiated product with a rules engine, process templates, a low code development platform, robotics, and integrated customer engagement applications. We think Blueprint strengthens its portfolio.

The company is emerging from a model transition that should allow for a multiyear path for margin improvement and better revenue visibility.

There is uncertainty around the long-term financial targets for Pegasystems, with investor skepticism around the rule of framework, both in terms of degree and timing.

Customer service use cases, which is primarily where the firm operates, are ripe for disruption from AI.

CEO and Founder Alan Trefler is over 65 years old, owns a substantial portion of the company, and has been crucial to the firm’s success. While we see no immediate management issues, this represents heightened risk for investors.