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Is Appian About to Checkmate Its Top Rival?

Motley Fool - Thu Nov 17, 2022

Appian (NASDAQ: APPN) stock is down 54% this year as slowing growth, widening losses, and fears of a recession have all weighed on the low-code software company.

However, the most important thing for investors to watch with the cloud stock may have nothing to do with its quarterly earnings reports. That's because Appian has been awarded a jury verdict of $2.06 billion in Virginia state court after it sued rival Pegasystems (NASDAQ: PEGA) for theft of trade secrets.

Appian was awarded those damages in May, and in September the court entered final judgement, which included a 6% interest penalty, equal to $122 million a year, against Pegasystems that it must pay if the verdict stands after the appeals process.

Given the unusually large award, the outcome has serious consequences for both Appian and Pegasystems. Let's review the details of the case before examining the implications for each side.

How Appian won $2 billion

According to the facts presented in the case, Pegasystems sought out a contractor who wasn't loyal to Appian but who had access to proprietary information as well as trial versions of its software. Internally, Pegasystems referred to this operation as Project Crush and called the contractor, Youyong Zou, a spy. They also made up a name for Zou, calling him Matt, and the operation included Pegasystems CEO Alan Trefler, who also had his own alias.

Zou illegally provided Appian's software and other proprietary documentation to Pegasystems, and Appian's complaint accused Pegasystems of stealing

trade secrets and confidential information and then using them to damage Appian's business and reputation, and to steal Appian's customers and potential customers.

The jury found that to be true in its verdict.

Appian was awarded damages for Pega's trade-secret misappopriation, and Pegasystems was also found to be in violation of the Virginia Computer Crimes Act.

Where the case stands today

Immediately after the final judgement was rendered, Pegasystems filed for appeal, saying,

we strongly disagree with the claims asserted by Appian in the case and the trial court outcome. These are not supported by the facts of the case or the law and are the result of significant error by the court. We believe we have strong grounds to overturn this result.

Not surprisingly, Appian sees the matter differently, and according to Appian co-founder and Chief Partner Officer Marc Wilson, the verdict is already becoming an albatross for Pegasystems. In an interview with The Motley Fool, Wilson said that Appian is hearing from partners and customers that Pega is becoming a "toxic vendor," meaning the verdict is damaging its reputation. Pega will also have to disclose that it was found guilty of the Virginia Computer Crimes Act in public sector bids, which is likely to hamper its ability to work with the federal government and other such entities. Wilson also said that customers, partners, and practitioners are moving away from Pegasystems and have inquired about migrating to Appian.

Pegasystems, on the other hand, hasn't shied away from addressing the case, saying it brings it up with clients and discussed it on its recent earnings call. Pega isn't denying that the operation happened but instead describes it as normal competitive analysis, including assessing competitors' products. The company's third-quarter earnings report showed little impact from the verdict, and annual contract value rose 16% on a constant-currency basis to $1.1 billion.

What the verdict means

Two-billion dollars is a substantial sum for almost any company, and that's certainly true for both Appian and Pegasystems.

Appian's market cap is currently $3 billion, while Pegasystems' is just slightly higher at $3.15 billion. The $122 million annual interest expense alone represents a significant annual payment for a company that size as well. Pega has said that it "has the financial strength to pay a judgment if it ever becomes necessary."

As of its most recent quater, Pegasystems had $275 million of cash and equivalents on its balance sheet but just $1.17 biilion in total assets, meaning the company would have to take on significant debt or dilute shareholders by roughly two-thirds in order to come up with the $2 billion.

In other words, if the verdict and the $2 billion award stand, Appian will not only receive a significant windfall, but it will significantly impair its top competitor.

Pega is expected to file its appellate brief in February, and the appeals process could take years to play out. As it stands now, the award would be a gamechanger for Appian.

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Jeremy Bowman has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Appian. The Motley Fool recommends Pegasystems. The Motley Fool has a disclosure policy.

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