2023-04-13 23:06:22 ET
Summary
- Progress Software has driven ~12% total revenue CAGR over the past year while expanding margins to about 40%.
- The company's strategy of acquiring software companies with good retention metrics, high operating margins, and a high recurring revenue mix has contributed to topline growth and margin expansion.
- With its focus on inorganic growth and a strong management team, PRGS is well-positioned to continue to grow in the future.
- The current FCF multiple for Progress is 16x EV/FCF, which is one of the lowest in the software industry, indicating a rare value-play opportunity in a growth world.
Thesis
Progress Software Corporation ( PRGS ) is a profitable software company with a focus on achieving growth through inorganic means, such as mergers and acquisitions. The company has a strong portfolio of infrastructure software products that allow businesses to manage their critical applications. PRGS has a high recurring revenue mix, and the company’s growth strategy is focused on acquiring software companies that fit its existing portfolio, good retention metrics, and high operating margins. The company has already made three acquisitions under this strategy, and it has driven a ~12% revenue CAGR over the past five years while expanding margins to ~40%. I keep a buy rating on PRGS stock with a December 2023 price target of $64 based on ~20x EV/CY23E, which is at a discount to the comp group of legacy software companies.
PRGS stock price movement (Seeking Alpha)
Solid Infrastructure Software Portfolio Running Mission Critical Use Cases
Progress offers a solid portfolio of infrastructure software products enabling organizations to develop, deploy and manage mission-critical business applications. Its software product set works behind the scenes powering a lot of important and pervasive use cases. OpenEdge powers a lot of the loan origination systems in US including Quicken Loans, Freedom Mortgage and JP Morgan Chase, among others. OpenEdge also powers a number of ERP systems, including Infor, QAD and TOTVS – a Brazilian ERP system, among others. Progress’s high performance data connectivity offerings are used by the likes of Oracle and SAP, in addition to legacy BI tools like IBM Cognos, or SAS institute, while its business rules engine, Corticon, validates every transaction on eBay from a risk management angle. More recently, Progress has been shoring up its offering in the DevOps world, which is a growing area of investment within IT, with the acquisition of Ipswitch, Chef, and Kemp. In aggregate, across its portfolio, over 100K customers use its solutions directly or indirectly, and over 1,700 software companies have built their products on top of Progress’ software stack. Progress also has a 3M+ developer ecosystem, and 6M+ business users work with applications that run on Progress. Customers include Microsoft, Amazon, Salesforce, SAP, Toyota, Caterpillar, Ford, Siemens, Abbott, J&J, WHO, American Express, UBS, Wells Fargo, Walmart, Ikea and PepsiCo, among others.
Innovative Portfolio for High-Impact Applications (Company Presentation)
Driving Total Growth Strategy by Operationalizing PE Playbook
Progress has laid out a total growth strategy which aims to grow the topline of the business at about a low double digits , leaning more toward inorganic growth as opposed to organic growth, aiming to double the size of the business in five years while more than doubling EBITDA and FCF. The inorganic growth is fueled by an active M&A pipeline, currently focused on software companies with $50-100M in revenue, growing single digits with a high recurring revenue mix, good retention metrics and good operating margins, which can be further improved to potentially above the corporate operating margin of 40%, driven largely by cost synergies achieved after the acquired assets are operationally integrated within the broader company. Despite some headwinds posed by the pandemic in 2020, Progress has executed well to this strategy so far, driving ~12% total revenue CAGR over the past year while continuing to expand margins to about 40%.
Continued Investments in R&D Persisting Portfolio Relevance Maintaining Stickiness
A core element of the total growth strategy is maintaining a strong dollar retention rate and keeping a check on churn. As such Progress continues to invest 18-20% of revenue on R&D driving product innovation to keep even its products relevant in the market, driving stickiness for long term customers. For instance, Progress recently introduced the ability to run OpenEdge, its core legacy product, on AWS as well as introduced Docker Support for Progress Application Server, allowing customers to run it in containers. Additionally, its go-to-market is largely focused on customer retention and relationship management, as opposed to demand gen or new customer prospecting, thus focused on maintaining stable retention. Finally, even though Progress might not be focused on getting new customers, Progress’ revenue is positively impacted by the organic growth of 1700+ independent software vendors that have built on top of Progress’ software stack, which also partially offsets some churn. All of the above has driven an improvement in retention (based on ARR) over the last few quarters underscoring the early success of the strategy.
Total Addressable Market
Progress touches across multiple markets, including Application Development Platform (OpenEdge, Kinvey), DevOps Tooling (Chef, Kemp, WhatsUp Gold), Content management system (Sitefinity), Business rules management system (Corticon) and Data Connectivity and Movement (DataDirect, MOVEit), among other things.
I think Progress plays in very big market categories and in aggregate has a large market opportunity. For instance, Gartner estimates the worldwide application development market alone to be ~$14 billion in 2020, which is expected to grow at a 9% CAGR from 2020-2025. The DevOps market is expected to be worth ~$15 billion as of 2026. Application development and DevOps are only two of the various other markets that Progress participates in, and hence the overall TAM for Progress is considerably high in aggregate.
However, I would like to stress that Progress’s strategy is not to focus aggressively on organic revenue growth at the expense of margin or free cash flow but to keep organic growth at flat to low-single-digits. Progress plans to drive organic growth by innovating continuously to maintain the relevance of its products so as to make it very lucrative for its existing customers to continue to use Progress and grow their footprint, thus driving strong net retention.
Valuation
I have examined a group of comparable companies to inform my view of Progress’s valuation and rating. I think it makes the most sense to look at its valuation on an EV/FCF basis, as Progress generates a considerable amount of free cash flow. I have used a comp group with legacy software companies that have>10% FCF margins and that are expected to grow revenue 0-15%, aligning with Progress’s financial model. Progress is currently trading at 16x EV/FCF, which is at a big discount to the comp group. Progress has a higher gross margin than the group and a similar FCF margin profile. While Progress has a superior profitability profile, I think the discount to the group is warranted, given the inorganic nature of its growth strategy. I keep a buy rating on the stock with a December 2023 price target of $64 based on ~20x EV/CY23E, which is at a discount to the comp group of legacy software companies.
Risks
Progress is employing a strategy that leans more on inorganic growth vs. organic growth, with a desire to execute meaningful acquisitions over the near-and medium term. Successfully employing this strategy requires both financial discipline as well as operational ability to successfully drive cost synergies. An inability to do so could negatively impact Progress' revenue growth, profitability profile, and stock price.
Progress' strategy depends on stable retention rates, which rely on the continued innovation driving relevance of its software portfolio. If its software products fall behind vs. newer competitive alternative, customers might choose to move away from its products driving higher churn and negatively affecting retention rates.
Final Thoughts
Progress is a software company that has a unique and profitable business model. Progress has been able to execute on its growth strategy, driving ~12% total revenue CAGR over the past year while continuing to expand margins to about 40%. The current FCF multiple for Progress is 16x EV/FCF, which is one of the lowest in the software industry, indicating a rare value-play opportunity in a growth world. The company's strategy of acquiring software companies with good retention metrics, high operating margins, and a high recurring revenue mix makes sense for its business model. With its focus on inorganic growth and a strong management team, the company is well-positioned to continue to grow in the future. I keep a buy rating on the stock with a December 2023 price target of $64 based on ~20x EV/CY23E, which is at a discount to the comp group of legacy software companies.
For further details see:
Progress Software: Attractive At Current Levels