Pegasystems: Emphasizes AI and Launchpad at Investor Day

At Pegasystems’ PEGA investor day, the main areas of focus were generative AI, sales strategy, Pega Infinity, Pega Launchpad, and a reiterated commitment to the rule of 40. While we are pleased that Pegasystems’ model transition is nearly complete and the firm has a clear direction, we see no changes to our long-term thinking and maintain our fair value estimate of $52 for the no-moat name. If Pegasystems were to meet its three- to five-year operating targets, we see material upside to our estimates, particularly on the profitability front, due to cost reductions. Along with our other software names, shares of Pegasystems have performed well midway through the year. We view shares as fairly valued but would prefer to invest in cleaner and wide-moat software names such as ServiceNow and Salesforce.

Management updated its financial framework for the next 3-5 years. In the duration, Pegasystems is targeting 80% gross margin, from 74% previously; sales and marketing of 30% of revenue, from 43% previously; and research and development of 17% of revenue, from 20% previously. We view these goals as aspirational but note that Pegasystems has demonstrated follow-through on its profitability focus. It also raised its fiscal year 2023 guidance for free cash flow to $180 million from a previous guide of $150 million. Management remarked that although it will not reach its rule of 40 goal this year, the firm is still committed to achieving this milestone on a consistent basis.

Unsurprisingly, generative AI was discussed at length. Pegasystems has been using its customer decision hub as an AI tool for about 15 years. CEO Alan Trefler commented that Pegasystems will employ a combination of public and privately trained models, as well as an embeddings model and a vector database. We are impressed with the firm’s history of using AI and are interested to see how use cases proliferate and are further integrated into the Pegasystems platform over time.