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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 about when things go wrong? Well, that’s why we need fantastic computing incident response and rapid iterative software development. Pager (NYSE:PD) is a leader in this industry and serves more than a third of Fortune 500 companies. Its customers include Microsoft, Uber, Samsung, Slack, Costco, Mastercard, Cisco, BBC and many more.

PagerDuty Customers

PagerDuty Clients (Investor Overview)

The stock price had a bull run in 2020 and rose 260%. However, since the high inflation numbers were released in March 2021, it has nosedived 54% along with many other growth stocks. The stock is now inherently undervalued and trading at the lowest valuation since the pandemic. Let’s dive into the business model, financials, and valuation for the juicy details.

PD stock price chart
Data by YCharts

Digital business model

PagerDuty offers a digital operations management suite that can be segmented into four numerous product lines; DevOps, AIOps, process automation and business operations. The total addressable market across the four platforms is $36 billion.

PagerDuty TAM

PagerDuty TAM (Investor Presentation)

The company’s flagship product is its IT incident response service which is primarily used in a DevOps software culture. You can think of “DevOps” simply as a combination of “Software Development” and “IT Operations”. A “DevOps” culture aims to bridge the gap between siled teams to improve software reliability and development speed. Below you can see a sample PagerDuty dashboard that allows tracking “All Incidents” and configuring alerts.

PagerDuty Computer Incident Response

PagerDuty IT Incident Response (official site)

“Answer sets” can even be set up, allowing users to create responses to common bugs and issues, which is a huge time saver.

Teams can even customize how they want to handle incident response. For example, a team member can choose between multiple escalation levels and the type of alert such as a phone call, text message, or push notification.

A key principle of great SaaS platforms is the ability to integrate with other platforms. In this case, Pager Duty offers over 650 integrations on popular platforms such as Salesforce, AWS, ServiceNow, Zoom and more.

PagerDuty integrations

Integrations (PagerDuty website)

Growing finances

PagerDuty delivered strong earnings for the first quarter of 2023. Revenue was $85.4 million, up a rapid 34.3% year-over-year and beating expectations analysts.

PagerDuty Quarterly Revenue

Quarterly revenue (Investor presentation)

This was due to an increase in the total number of paying customers to 15,040, up 7% from 13,918 customers in the same quarter last year. There has also been a significant increase in the number of customers with annual recurring revenue of over $100,000. These premium customers grew to 655, up 43% from 458 in the same quarter last year. This speaks to management’s “Land and Expand” strategy, which focuses on using one of its four main product lines to “land” before selling additional offerings.

PagerDuty High Ticket Customers

High Ticket Clientele (Investor Relations)

The dollar-based net retention rate also showed a nice 5% year-over-year increase to 126%. This shows that customers find the product “sticky” and also spend more.

PagerDuty dollar-based net retention rate

Retention rate (Investor presentation)

As a SaaS company, PagerDuty has a high gross margin of 82%, which is fantastic. But the company is operating with a heavy loss of -38% or -$32 million. However, when I take a closer look at the income statement, I can see that the company invested $31 million in R&D during the quarter and so without that investment it would be closer to “profitability” on a traditional basis .

PagerDuty margins
Data by YCharts

On a non-GAAP basis, the operating loss was only $2.3 million with a margin of -2.7%. Normalized EPS was -$0.04, which is a loss but exceeded analysts’ expectations.

PagerDuty has a strong balance sheet with current cash, cash equivalents and investments of $468 million and total debt of $307 million.

Advanced Assessment

In order to value PagerDuty, I incorporated the latest financial data into my advanced valuation model which uses the discounted cash flow valuation method. I forecast revenue growth of 29% for next year and 30% for the next two to five years, which is in line with management guidance and analyst estimates.

PagerDuty Inventory Assessment

PagerDuty Stock Valuation (created by author Ben at Motivation 2 invest)

I also projected that corporate margins will gradually improve from -19% next year (R&D adjustment included) to 22% over the next 7 years. The average operating margin for the software industry is 25%, so I think that’s achievable. In addition, I capitalized on the company’s R&D investments to increase the accuracy of the assessment.

PagerDuty PV

Pagerduty (Created by author Ben of Motivation 2 Invest)

Considering these factors I get a fair value of almost $35/share, the stock is trading around $25 at the time of writing and is therefore undervalued by around 28%.

As an additional data point, PagerDuty is trading at a price-to-sales ratio (forward) = 6.1, which is the cheapest level since the pandemic low in March 2020.

PS PagerDuty report
Data by YCharts

Compared to other enterprise SaaS platforms, PagerDuty trades at an average valuation (red line). It is cheaper than competitors Dynatrace (SP=9) and Freshworks (SP=7). But PagerDuty is more expensive than legacy enterprise platforms like SAP (PS=3.4).

PagerDuty vs peer PS ratio
Data by YCharts

Risks

High stock-based compensation

Stock-based compensation was $81 million over the past 12 months. This represents approximately 27% of turnover and is therefore substantial. Longer term revenue will need to start growing at a much faster rate than this expense, otherwise it will be difficult to achieve profitability. The good news is that I believe stock-based compensation is an essential part of employment at any tech company because it attracts top talent and aligns the team.

PagerDuty Earnings and Stock-Based Compensation
Data by YCharts

Potential recession/decline in IT spending

Many analysts predict a “shallow but long” recession, starting in the fourth quarter of 2022. Companies could decide to cut or delay IT spending for the year due to growing uncertainty. However, in the long run, the trend is towards increasing IT spending in organizations.

Final Thoughts

PagerDuty is a fantastic company that truly sets the standard for IT incident response and related automation. The company has an elite roster of customers and a $36 billion market opportunity. The recent decline in the share price now means that this stock is inherently undervalued and therefore could be a great option for the long-term investor.