Is PagerDuty Stock a Good SaaS Stock?
Successful technologists understand that the ability to learn new domains is as equally important as having subject matter expertise in a single domain. Breadth is as important as depth. Competent software engineers can often move around laterally within an organization because of their ability to learn. They can also move upwards while still maintaining technical competence. That’s because certain principles such as systems analysis and design are technology agnostic. But when it comes to hardware, it becomes antiquated just as quickly as it becomes popular.
If you’re not old enough to remember Handspring’s PalmPilot, you certainly won’t remember the humble pager. Still used by the majority of hospital staff, pagers were once the Bat Signal for everyone from utility workers to IT techs when storms knocked down power lines or a company’s homepage crashed. Understanding the use case for pagers may come in handy when discussing today’s company – PagerDuty (PD).
About PagerDuty Stock
In the fast-moving world of startups, software engineers are often responsible for doing everything, from writing code to managing their systems in production. A customer support call can often be followed by a bug fix and a “please try again” response to a flagship customer. That meant being on “pager duty” to respond to an IT issue 24/7. Inspired by an internal software tool at Amazon that handled on-call incident scheduling and alerting via pagers, San Francisco-based PagerDuty was founded back in 2009 by three software engineers who once worked for the e-commerce corporation. They figured other companies might be interested in a similar service for their own IT operations.
The trio secured the domain name PagerDuty and the rest is history: The company raised more than $170 million from respectable venture capital firms with names like Andreesen Horowitz and Accel, among others. Over the last decade-plus, PagerDuty has expanded from a single product focused on on-call management for developers to a multi-product platform that uses machine learning for what it calls digital operations management, which apparently goes beyond simply speeding up the time it takes to respond to IT incidents. We’ll dive more into that momentarily.
The company eventually IPO’d in 2019 at a valuation of about $1.8 billion, and PagerDuty stock jumped nearly 60% on opening day. Today, it sports a market cap of about $2 billion, nearly back to the drawing board after a volatile few years. At one point, it reached a market cap of about $4.6 billion in early 2021 when nearly every tech stock was red hot, but has since flamed out a bit. While the company’s stock value has had its ups and downs, revenues have been on a consistent growth trajectory.
Last year, PagerDuty had revenue of more than $281 million, a jump of 32%. This year the company is projecting to finish 2022 with between $365 million and $370 million, representing a growth rate of about 30%.
What is Digital Operations Management?
The typical enterprise IT environment has grown ever bigger and more complex, with millions of lines of code and an increasingly denser web of integrations and disparate systems that need to play nice with one another. That means things break all the time, and one outage could represent thousands or millions of dollars in lost revenue. At least that’s the pitch from PagerDuty, which has developed a digital operations management platform, PagerDuty Operations Cloud, which uses machine learning and automation to help teams act quickly to resolve issues.
How? The platform continuously collects data signals from any source and integrates with any tool in the IT ecosystem – 700 integrations and counting. A digital signal includes everything from IT incidents and IoT signals to security alerts and business transactions. The algorithms harness these data signals to “reduce noise, create context and recommendations, and intelligently highlight past incidents to accelerate learning by teams … The platform acts as the central nervous system for the digital ecosystem using a unique combination of human and machine data to help prevent future incidents from happening.” In other words, the platform enables users to address problems in near real time, fix security breaches, reassure customers having a nervous breakdown, and even drive business opportunities.
The use cases for the PagerDuty platform sound an awful lot like Splunk (SPLK), which leverages machine learning to better predict and help prevent IT, security, and IoT incidents, as well as to forecast key business indicators. Splunk happens to be one of the 700 integrations that PagerDuty supports, and an obscure slide deck we came across from 2017 (authored by Amazon Cloud) describes how these companies began working together so PagerDuty ($281 million in 2022 revenues) could better understand incidents using the rich datasets on offer from Splunk ($2.67 billion in 2022 revenues). The latter belongs to a domain called application performance monitoring (APM), while the former offers a more holistic and tactical solution that focuses on incident response. Since this entire domain of SaaS applications is rife with M&A activities, trying to define what a company actually does relative to other companies becomes very difficult. That’s where common SaaS metrics can be helpful in understanding what a business does.
PagerDuty is a Pure-Play SaaS Stock
PagerDuty relies primarily on a software-as-a–service (SaaS) business model, which involves offering a cloud-based subscription for its digital ops management products. Last year, we wrote about why SaaS stocks command a premium in the market. Topping the list is the fact that they boast predictable revenue streams and easy-to-understand metrics to evaluate the business. Let’s take a look at how PagerDuty stacks up as a pure-play SaaS stock.
Revenues and Retention Rates
Annual recurring revenues (ARR) is the amount of money a SaaS company is contractually obligated to receive in a given year if absolutely nothing changes in terms of customers, contracts, and costs. This is different from total annual revenues, which reflect the amount of money received in a 12-month period. As of July 2022, PagerDuty had more than 15,000 paying customers. Nearly 700 of those had an ARR of more than $100,000 – compared to about 500 at the same time last year. More than 40 customers had an ARR of $1 million or more at the end of last fiscal year. Unfortunately, PagerDuty doesn’t provide total ARR or details about monthly versus annual contracts.
Net retention rate (NRR) simply refers to how much more money a customer is paying compared to a year ago. PagerDuty has had a NRR above 120%, about an average number for SaaS stocks, for seven consecutive quarters. It also had a gross retention rate, the percentage of existing customers that renewed their contracts, of above 95%. Ideally, that number would be 98% or higher. No single customer represented more than 10% of revenue, and even its 10 largest customers represented only about 11% of total revenue.
If you’re selling subscription cloud-based software, you better have a high gross margin, meaning the direct costs to provide the product should be pretty darn low. PagerDuty had a very respectable gross margin of more than 82% which means profitability shouldn’t be that far away if they decide to tighten the purse strings. With $470 million in cash and losses of $38 million last quarter, PagerDuty has a runway of about three years.
Return on investment, or ROI, is a way to gauge how much value a customer derives from investing in a product or service. PagerDuty claims its typical top-tier customers with an average of 2,500 responders resolve incidents two hours sooner and experience 14 fewer hours of downtime every month using its platform. That reportedly translates into annual savings of up to $9 million and a return on investment of 680%. Companies that save other companies money will fare well in good times and bad.
Should You Buy PagerDuty Stock?
PagerDuty stock checks a lot of the right boxes when it comes to being a pure-play SaaS stock. Based on the ROI and gross retention rate, most PagerDuty customers appear to consider its platform necessary rather than discretionary. That’s important as other tech companies start sending their employees to the unemployment line, something we’ve seen from the likes of Meta and Twitter just this last week.
Are there any downsides? Of course! The company says it will be profitable by next year, but the current quarterly trend doesn’t really support that particular claim.
In addition, a “significant majority” of revenue comes from the company’s incident response offering, which will likely be the case for the foreseeable future. Unfortunately, PagerDuty does not provide much granularity into its revenue streams. We do know that less than a quarter of PagerDuty’s revenues come from outside of the United States, so we’d like to see more international diversification.
On the other hand, the company estimates that its total global penetration is less than 5%, with a total addressable market (TAM) of at least $36 billion. PagerDuty used math that even an MBA can understand by simply multiplying its estimate of 72 million potential users by average product revenue per user, which apparently works out to be $500 per person. So, in the case of the average customer with 2,500 responders, that works out to $1.25 million in revenue.
Understanding technology solutions may be a skill that doesn’t change over time, but what changes are the number of entrants. Combine that with a propensity to acquire and you’ll end up with domains that even the MBAs over at Gartner have a hard time classifying using the labels du jour. PagerDuty helps save companies money through better incident response and their SaaS metrics aren’t half bad. As always, a decision to go long the stock stacks up relative to what you’re already holding and the exposure you’re looking to gain.
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