Progress Software Not in Regress (PRGS)

By David Harper | March 22, 2007 AAA

Progress Software (Nasdaq: PRGS) beat expectations this week and was recognized with a price bump that caps a year-long recovery.

The recovery started earlier, as the company first solved its option backdating problems and, second, benefited from speculation that it should be on Oracle's well-capitalized acquisition radar.

In a valuation nutshell, the price now fully reflects robust fundamentals. A growing customer base shows up in growing cash flow, although the trailing price-to-earnings (P/E) ratio is high:

1698_PRGS.gif

Against forward guidance, the valuation is rich but not exorbitant. At $30, the forward P/E is about 27x ($30 price divided by estimated $1.10 fully-diluted GAAP EPS). In the grow-or-perish software business, where mutiples must be higher as a function of reality, that's reasonable except that projected revenue growth rate is only 6% (i.e., to $475 million for fiscal 2007).

Still, Progress is a key player in a critical segment of the software sector. But alas it's got to be one of the toughest to understand. Application infrastructure is sufficiently complex (or boring) that most street commentary is reduced to groping the financials. But this company is a good example of the new face of investing and why it's not your grandfather's stock market anymore -- nine products that touch on just about all things software from mission-critical standards (i.e., XML and XQuery), relational databases, 4GL development tools and, most importantly of all, web-based service architectures.

The OpenEdge Platform
Their flagship product is the OpenEdge platform. This is a giant workbench with a killer set of tools. There are two main sorts of customers. First, a big company, with lots of loosely connected, far-flung applications can use OpenEdge to build master applications that tie together prexisting applications and attach new components. By using a fourth-generation language (4GL), developers can deploy and change products quickly because 4GL languages perform much of the heavy lifting. Much more so than 3GLs like C++ and Java, which require the help of serious code geeks.

(Note an interesting megatrend is underway -- programming languages become more user-friendly as they converge to graphical 5GLs. Yesterday, a business analyst maybe crunched numbers. Today, he/she is expected to know something about code development. Soon ordinary folks will build applications.)

The second sorts of customers are independent software vendors (ISVs) who use OpenEdge to build specialized software applications that serve "vertical markets" like casinos. In either case, most companies still have a quilt-patch of software distributed software assets, and so there will strong demand for "application integration." It's safe to predict a bull market for application coherence.

Service-Based Architecture
Maybe the best reason Progress matters is the importance of service-oriented architectures. Okay, this is a whole thing unto itself and a whole debate to go along. But basically, the idea is related to some of these mashup applications that you see on the internet. Google (Nasdaq: GOOG) maps is really popular; lost of developers have plugged into the Google Map database and used it as a component to build their own applications. They are using Goolge maps as a service provider. As if they outsourced application and database development to Google!

We haven't even started to see the realization of this service-based architectures. Seriously, there isn't a major software company that's not working on it. These will enable richer connections within companies and externally, to customers and vendors. And just as connecting cities requires infrastructures, so does data need paved roadways and rules for sharing. OpenEdge, for example, utilizes XQuery to process data that is stored in structed format (XML). So, in short, Progress builds software that helps companies develop tools that connect to data on the modern information infrastructure.

The Bottom Line
Progress Software presents a solid opportunity, but there is still fierce competition from the usual suspects -- Oracle (Nasdaq: ORCL) and IBM (NYSE: IBM). Also, BEA Systems (Nasdaq: BEAS). But especially don't underestimate Microsoft (Nasdaq: MSFT) and their SharePoint product line -- the value added resellers (VARs) and integrators seem to love this, and because they are in the trenches, they are very good forecasters.

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