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PagerDuty: Promising Enterprise Software Firm Showing Growth Since Its IPO

Luis Sanchez, The Motley Fool

PagerDuty (NYSE: PD) has been one of the more successful IPOs launched in 2019, with its stock price up about 65% from its $24 per share IPO in early April. PagerDuty is an enterprise software company providing tools to help other companies manage their technology systems more effectively. Virtually every company uses technology in some aspect of day-to-day operations, translating into a huge market opportunity for companies like PagerDuty. Investors are betting that PagerDuty can generate strong growth in the coming years as it capitalizes on this opportunity.

PagerDuty's product: Software for software

PagerDuty's key product is a software solution it labels on-call support, which refers to the idea that companies and their engineers are always on call to keep their technology running and support their customers. PagerDuty's software is embedded in a customer's software system and collects data from system outputs and human interactions. PagerDuty uses that data to determine if the system is running properly and to generate analytics that can be used to assess the health of an IT system and find ways to improve it.

At its core, PagerDuty's offering is an analytics tool that helps businesses harness technology more effectively. The company collects data and runs advanced analytics, including machine learning and artificial intelligence, to mine for unique and powerful insights. Once data is collected and analyzed, it can be used to improve a product, enhance customer support, assess cybersecurity, or any number of other use cases depending on the customer's needs.

Person holding a pager device.

Image Source: Getty Images.

It's admittedly tough to understand specifically how PagerDuty services its clients because its product has such broad applications, but the company provides a few client case studies.

For example, Box, an enterprise software company, uses PagerDuty to monitor its customers and ensure it is always online. If Box's system goes down, PagerDuty promptly notifies the correct technical team to fix the outages as they are reported. Good Eggs, an online grocery business, employs PagerDuty to analyze data from its warehouses to monitor its refrigerators to ensure its food doesn't spoil. Finally, Okta, an enterprise software company, uses PagerDuty to identify and resolve customer incidents in real-time.

PagerDuty's product has diverse use cases across many industries. The value proposition to the customer is dependent on how much access the customer gives PagerDuty to collect and process data. The more data collected, the more useful PagerDuty's services and insights can potentially be. Some customers will use PagerDuty as an outsourced IT monitoring service, while others will use it to find opportunities for business process improvement and task automation.

A large market opportunity

PagerDuty has a large market opportunity because virtually every company uses technology to assist with aspects of its core business. The company estimates a $25 billion market, which is based on its estimate of 85 million potential users who work in IT, security, and customer support for large companies. PagerDuty also estimates that it currently has a less than 1% share of this market.

The market isn't an open field for PagerDuty. Competition exists from a few large companies including Atlassian and Splunk. However, PagerDuty's biggest competitor is in-house efforts by companies to collect and analyze their own data. Most companies take a do-it-yourself approach to monitoring systems and developing operational analytics and haven't considered contracting out the work.

PagerDuty has an extremely large market to tackle, but in order for it to be successful, it needs to demonstrate that its capabilities are far better than a customer's in-house efforts. This is a classic bet that companies will save money and get more value from a process by outsourcing it to a specialized provider. PagerDuty is well-positioned to demonstrate this value proposition.

Financial performance

2019 has already seen several other enterprise software IPOs debut. PagerDuty is atypical in the sense that its technology has a wide scope of potential use cases and target customer types. But when it comes to its financial metrics, PagerDuty has followed a similar path to other recent tech IPOs. The company is growing revenue at a rapid rate -- 48% year-over-year growth in 2018 -- but is unprofitable and shows no near-term plan or desire to prioritize profitability over sales growth.

Metric 2017 2018 12 months ending April 30, 2019
Total revenue $79.6 million $117.8 million $130.1 million
Gross profit $66.9 million $100.6 million $111.3 million
Gross margin 84% 85.4% 85.5%
Net loss ($38.1 million) ($40.7 million) ($46.2 million)

Data Sources: PagerDuty financial reports, Capital IQ.

If the company is correct in the assessment that its potential market opportunity is $25 billion, then it has a long runway from its current $130 million in revenue. Put into context, it makes sense for the company to spend aggressively now and run a net loss in order to add customers before potential competitors have the chance.

Once PagerDuty's software has been installed, it is not easy to switch to a competitor because of how integrated it is within a customer's system. Better yet, PagerDuty's software subscription represents recurring revenue that grows with customers as they add more users to buy more services from PagerDuty. This strategy of "land and expand" is central to the company's growth strategy. Over the last three years, PagerDuty's dollar-based retention rate exceeded 130%. This means existing customers are spending more money with PagerDuty each year, even after taking into account customers the company lost.

The company's high 85% gross profit margin implies that PagerDuty could be profitable if it is able to leverage its fixed costs. This shouldn't be a problem if the company can quickly grow its revenue.

Looking ahead

PagerDuty is an intriguing growth company. It appears to be an early player in what will likely be a much larger industry of providing tools to improve enterprise software systems. PagerDuty's product has the promise to address a diverse set of challenges faced by enterprises across all industries. However, PagerDuty does face competition, and the biggest risk is that a competitor delivers a superior product, causing PagerDuty to lose customers and fall into obscurity. This would be a tough pill to swallow for the company, because at this point, it essentially has just one core product: the on-call monitoring software.

The other, more obvious challenges for PagerDuty are how fast it can grow and when it will be profitable. Last year's 48% revenue growth was nice, but PagerDuty will need to keep up a similar pace if it plans to live up to the high valuation implied by its $3 billion market capitalization. Profitability is a secondary concern and is assumed to be achievable with greater sales volumes.

All in all, there is a lot to like about PagerDuty, and the company is certainly worth following as it charts its progress over the coming months and years.

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Luis Sanchez has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Atlassian, Box, Okta, PagerDuty, Inc., and Splunk. The Motley Fool has a disclosure policy.

This article was originally published on Fool.com