2023-09-22 11:50:40 ET
Summary
- PagerDuty, Inc.'s recent shift to a consumption-based revenue model raises concerns about its potential success, given the historical challenges associated with such models.
- A comparison with Splunk, which operates differently but shares similarities, highlights PagerDuty's notably higher forward-looking valuation.
- PagerDuty's revenue growth rates are slowing down. So, I don't find paying 28x next year's EPS to be attractive.
Investment Thesis
PagerDuty, Inc. ( PD ) is a digital operations management platform that helps businesses respond swiftly to incidents and enhances operational efficiency by centralizing incident response and automating critical workflows. It offers a suite of solutions, including Incident Response, AIOps, Process Automation, and Customer Service Ops, to ensure improved customer experiences.
On the one hand, we could make the case that the stock is cheaply valued, after all, it's hardly gone anywhere in the past several years. But on the other hand, PagerDuty is still priced at around 28x next year's non-GAAP EPS. This is a multiple that I find fully unattractive.
PagerDuty's Near-Term Prospects
PagerDuty is a digital operations management platform for modern businesses, enabling rapid incident response and effective issue resolution. It goes beyond incident management by reducing noise, predicting performance issues, and accelerating digital transformation for
PagerDuty collects data from various systems and then correlates abnormal signals to mobilize responders in real-time, improving operational efficiency and customer experiences.
The graphic that follows illustrates PagerDuty's newest offering, its AIOps offering (AI Operations).
PagerDuty continues to evolve into a multi-product platform serving a broad range of customers within the IT sector, with the goal of cutting through different signals on its customers' platform that may be little more than noise and then orchestrating the right response.
Indeed, this is at the core of what PagerDuty offers its customers, a very high ROI figure (see below), that sees its offering being picked up by all kinds of enterprises, from global multinationals to small disruptive startups.
Now that we understand what PagerDuty does and its near-term prospects, allow me to describe why I struggle to get bullish on this stock.
Revenue Growth Rates Mature
Above we see that PagerDuty's growth rates are rapidly fizzling out. There's no ambiguity here. Indeed before one should opine that PagerDuty is being conservative with its guidance, allow me to remind readers that PagerDuty had already downwards revised its guidance together with its previous quarter's results, fiscal Q1 2024.
Secondly, and for me the most critical aspect of PagerDuty's revenue growth rates slowing down, is that PagerDuty has now sought to move over some of its products to a consumption-based revenue.
In my experience, I've hardly ever found consumption-based business models to work.
The graphic above is not an exclusive list by any means. Instead, it's a select list of companies that came to my mind that have consumption-based revenue streams.
With a consumption-based revenue stream, rather than you seeking to maximize your customer's use of your platform, you are charging them for using your platform.
The example I offer to demonstrate the drawback of this method of charging your customers is Blockbuster versus Netflix ( NFLX ). One you pay per view and one you pay to binge. What business ultimately thrived?
PD Stock Valuation - Far From Cheap
If we look out to fiscal 2025 (starting April 2024) and assume that PagerDuty's non-GAAP EPS line grows by around 20% y/y from $0.65 to $0.78 of next year's EPS, this leaves this stock priced at about 28x next year's EPS.
Is that a cheap valuation? I struggle to believe so. Allow me to provide an indirect example. Splunk Inc. ( SPLK ) doesn't really compete with PagerDuty directly, although Splunk can be used to detect and identify issues through data analysis, rather than as an incident response platform, like PagerDuty. Nevertheless, according to my estimates , Splunk was acquired at about 19x forward FCF. Yes, Splunk's growth rates looked a tiny bit slower than PagerDuty's. But at the same time, it's significantly more cash flow generative.
The Bottom Line
PagerDuty, Inc. plays a crucial role in facilitating swift incident response and operational efficiency for businesses.
While PagerDuty's stock valuation may appear cheap, it's already priced at approximately 28 times next year's non-GAAP EPS. The company's revenue growth rates are showing signs of maturation, which becomes evident when considering its revised guidance.
Additionally, PagerDuty's shift towards a consumption-based revenue model raises questions about its potential success. Historically, such models have proven challenging to execute effectively, contrasting with models like Netflix, which have thrived.
Considering these factors, PagerDuty's valuation seems far from favorable. A comparison with Splunk, which operates differently but holds some similarities, reveals that PagerDuty's forward-looking valuation is notably higher. Consequently, I find it challenging to adopt a bullish stance on this stock.
For further details see:
PagerDuty: Now On Consumption-Based Pricing, At 38x EPS? Not For Me