We live in a high speed connected digital world, our expectations of digital technology have never been higher and we expect things to just “work”. But what if you make a mistake? That’s why we need incredible IT incident response and rapid iterative software development. PagerDuty (NYSE: PD) is a leader in this industry and serves more than one-third of the Fortune 500. Sample customers include Microsoft, Uber, Samsung, Slack, Costco, Mastercard, Cisco, BBC and more.
The stock price became a momentum driven bull run in 2020 and rose 260%. However, since the high inflation numbers were released in March 2021, it has fallen 54% of the eye along with many other Growth stocks. The stock is intrinsically undervalued now and trading at the lowest valuation since the pandemic. We dive into the Business Model, Financials and Valuation for juicy details.
Digital Business Model
PagerDuty offers a Digital Operations Management suite that can be divided into four multiple product lines; DevOps, AIOps, Process Automation and Business Operations. The Total Addressable Market across all four platforms is entering a staggering $ 36 Billion.
The company’s core product is IT Incident Response service that is primarily used in a DevOps software culture. You can think of “DevOps” as just a combination of “Software Development” and “IT Operations”. A “DevOps” culture aims to bridge the gap between siled teams to improve software reliability and speed of development. Below you will find an example of a PagerDuty Dashboard that allows “All Incidents” to monitor and setup Alerts.
“Response plays” can even be setup that allows users to create responses to common bugs and issues, which is a major timesaver.
Teams can also Customize how they want to handle incident response. For example, a team member can choose between multiple levels of escalation and an alert type such as Phone Call, SMS, or push notification.
A key principle of good SaaS platforms is the ability to integrate with other platforms. In this case, Pager Duty offers over 650 integrations with popular platforms such as Salesforce, AWS, ServiceNow, Zoom and many more.
Growing Finance
PagerDuty generated strong revenue for the first quarter of 2023. Revenue was $ 85.4 million, rising 34.3% year-over-year rapidly and exceeding analyst expectations.
This was driven by an increase in total paying customers to 15,040, up 7% from 13,918 customers in the same quarter last year. There has also been a huge increase in customers with annual recurring revenue in excess of $ 100,000. These high -ticket customers rose to 655, up 43% from 458 in the same quarter last year. It’s a testament to the “Land and Expand” management strategy that focuses on using one of its four core product lines to “land” before selling additional offers.
The Dollar Based Net Retention Rate also showed a nice increase of 5% YoY to 126%. This shows that customers are looking for the “Sticy” product and are also spending more.
As a SaaS company, PagerDuty has a high gross margin of 82% which is very good. But the company is running at a huge loss of -38% or -$ 32 million. However, when I look closely at the earnings statement, I can see the company invested $ 31 million in R&D in the quarter and so without this investment they would be closer to “profitability” on a traditional basis.
On the basis of Non -GAAP operating loss is only $ 2.3 million with a -2.7% margin. Normalized EPS was -$ 0.04 which is a loss but beat analyst expectations.
PagerDuty has a strong balance with Cash, cash equivalents and current investments of $ 468 million and total debt of $ 307 million.
Advanced Appreciation
To value PagerDuty, I plug the latest finances into my advanced valuation model that uses the discounted cash flow valuation method. I forecast 29% revenue growth for next year and 30% for the next two to five years in line with management guidance and analyst estimates.
I also predict the company’s margins to gradually improve from -19% next year (including R&D Adjustment) to 22% over the next 7 years. The average operating margin for the software industry is 25% and so I believe this is achievable. In addition, I capitalized on the company’s R&D investments to increase valuation accuracy.
Because of these factors, I get a fair value that roughly $ 35/share the stock is trading at ~ $ 25 at the time of writing and is thus ~ 28% undervalued.
As an additional data point, PagerDuty trades at a Price to Sales (forward) ratio = 6.1, which is the lowest level since the pandemic subsided in March 2020.
In relation to other Enterprise SaaS platforms PagerDuty trades at a mid range valuation (red line). It is cheaper than competitors Dynatrace (PS = 9) and Freshworks (PS = 7). But PagerDuty is more expensive than legacy enterprise platforms like SAP (PS = 3.4).
Risks
High Stock Based Compensation
Stock Based Compensation was $ 81 million over the next 12 months. It generates approximately 27% of revenue and is thus substantial. Longer term Revenues need to start increasing at a faster rate than this cost otherwise it will be difficult to achieve profitability. The good news is I believe that stock -based compensation is an important part of any technology company’s job because it attracts the best talent and is team aligned.
Recession/Potential Reduction in IT Spending
Many Analysts forecast a “shallow but long” recession, starting in the fourth quarter of 2022. Businesses may decide to reduce or delay IT spending for the year due to increasing uncertainty. However, the long -term trend is towards increasing IT costs in organizations.
Final Thoughts
PagerDuty is an amazing company that is truly the gold standard for IT Incident response and associated automation. The company has a select list of customers and a $ 36 billion market opportunity. The recent pullback in the share price today means that this stock is intrinsically undervalued and thus could be a good option for long -term investors.