Cloud Migration Risks Will Erode Margins Yet Prompt Renewal

Key Takeaways

• Heavy reliance on acquisitions and legacy products exposes Progress Software to margin pressures, integration challenges, and risks from shifting enterprise technology trends.
  
• Cloud migration, competition from hyperscale vendors, and customer consolidation threaten recurring revenue streams and future top-line growth.
  
• Reliance on acquisitions, legacy product risks, and cloud-native competition threaten sustainable growth and profitability as innovation and customer retention costs rise.

Catalysts

Develops, deploys, and manages artificial intelligence (AI) powered applications and digital experiences in the United States and internationally.

• While Progress Software's integration of ShareFile and the acquisition of Nuclia suggest an ability to leverage cutting-edge GenAI and SaaS across their portfolio-potentially improving customer retention and supporting top-line growth-the accelerating migration of enterprise workloads to cloud-native and SaaS platforms could erode demand for Progress's legacy on-premise solutions, threatening long-term maintenance revenue.
  
• Although the company benefits from surging global requirements for data analytics and scalable infrastructure, an overreliance on M&A for product innovation and portfolio expansion introduces ongoing integration risk and heightens the possibility of margin dilution, which could negatively affect sustained earnings growth and margin stability.
  
• Despite strong secular tailwinds in AI-driven development tools and heightened cybersecurity needs, the rise of hyperscale cloud vendors and the widespread adoption of low-code/no-code platforms poses a risk to Progress's traditional middleware and developer tools, potentially depressing average selling prices and lowering future recurring revenue streams.
  
• While Progress has demonstrated disciplined expense management and uses AI internally to drive operational efficiency-reflected in robust operating margins near 40%-intensifying regulatory and global compliance demands may result in rising R&D and support costs, which could eventually compress net margins if revenue growth does not accelerate.
  
• Even as subscription-based licensing and cross-sell opportunities through new SaaS offerings like ShareFile increase revenue visibility, the ongoing consolidation among large enterprise customers may shrink Progress's addressable customer pool and empower major clients to demand discounts, increasing churn risk and putting pressure on future revenue growth.

Progress Software Future Earnings and Revenue Growth

Assumptions

• This narrative explores a more pessimistic perspective on Progress Software compared to the consensus, based on a Fair Value that aligns with the bearish cohort of analysts.
• The bearish analysts are assuming Progress Software's revenue will grow by 5.7% annually over the next 3 years.
• The bearish analysts assume that profit margins will increase from 6.6% today to 14.2% in 3 years time.
• The bearish analysts expect earnings to reach $145.8 million (and earnings per share of $3.15) by about July 2028, up from $57.6 million today. The analysts are largely in agreement about this estimate.
• In order for the above numbers to justify the price target of the more bearish analyst cohort, the company would need to trade at a PE ratio of 22.3x on those 2028 earnings, down from 35.5x today. This future PE is lower than the current PE for the US Software industry at 42.9x.
• Analysts expect the number of shares outstanding to grow by 0.47% per year for the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 9.9%, as per the Simply Wall St company report.

Progress Software Future Earnings Per Share Growth

Risks

• The company's organic growth appears modest, with ARR increasing only 2 percent year-over-year on a pro forma basis when accounting for acquisitions like ShareFile, which raises long-term concerns about sustaining revenue growth without continued deal-making.
  
• Heavy reliance on acquisitions to drive growth and diversification, while historically managed with discipline, exposes Progress Software to integration risks and possible dilution of operating margins and earnings quality over the long term, especially as the M&A environment becomes more competitive.
  
• Progress has significant legacy exposure with products such as OpenEdge, which face obsolescence risk as customers accelerate migration to cloud-native and SaaS platforms, potentially threatening recurring maintenance revenue and increasing churn.
  
• The expanding dominance of hyperscale cloud vendors and the shift toward integrated, cloud-native, or low-code/no-code development platforms could erode Progress's market share in traditional development tools and middleware, resulting in downward pressure on revenues and pricing.
  
• Increasing R&D investment and customer acquisition costs to stay technologically competitive in areas such as AI may squeeze net margins if topline sales from these innovations fail to accelerate proportionally, risking deterioration in overall profitability.

Valuation

• The assumed bearish price target for Progress Software is $57.0, which represents the lowest price target estimate amongst analysts. This valuation is based on what can be assumed as the expectations of Progress Software's future earnings growth, profit margins and other risk factors from analysts on the more bearish end of the spectrum.
  
• However, there is a degree of disagreement amongst analysts, with the most bullish reporting a price target of $83.0, and the most bearish reporting a price target of just $57.0.
  
• In order for you to agree with the bearish analysts, you'd need to believe that by 2028, revenues will be $1.0 billion, earnings will come to $145.8 million, and it would be trading on a PE ratio of 22.3x, assuming you use a discount rate of 9.9%.
  
• Given the current share price of $47.47, the bearish analyst price target of $57.0 is 16.7% higher.
  
• We always encourage you to reach your own conclusions though. So sense check these analyst numbers against your own assumptions and expectations based on your understanding of the business and what you believe is probable.