Description

PATH – Short Recommendation

Investment Recommendation:

UiPath (“PATH”) has historically been a market leader in the Robotic Process Automation (“RPA”) sector; however, new developments in Gen AI and further advancements in AI workflow automation among legacy enterprise platform vendors have created unforeseen competitive pressures that have fundamentally changed the company’s growth algorithm. With early signs of sales efficiency deterioration and clear need to increase spending on R&D initiatives, PATH is now fighting a herculean battle in an ever more commoditized RPA market that is facing disruption, with an uncertain trajectory to a stable growth and robust FCF end-state profile. At ~$12/share, PATH presents a short opportunity to bet on the continued technological Gen AI-driven dislocation among non-platformed RPA players. 

Business and Situation Overview:

PATH was written about in VIC previously back in Jun’22, which provides a good overview of the business. In a nutshell, PATH provides an RPA platform that helps enterprises identify, create, and execute automation opportunities in an organization, especially manual back-office processes. 

Recently, PATH saw management turbulence with former sole CEO, Rob Enslin, resigning in June after having assumed the role in February, with founder Daniel Dines returning to lead the company again as CEO. Although Dines’ return can be viewed as a net positive as it showcases a returning founder, Rob’s abrupt resignation came as a surprise and raises many more questions. Following these management changes, the company in April executed another round of layoffs representing ~10% of the workforce, only ~2 years after a RIF in June 2022. The company stated that the intended goal of the layoff was to focus more heavily on R&D in AI and sales initiatives. 

Short Thesis:

PATH presents a short opportunity for several key reasons: 1) PATH appears to be almost tapped out in its category TAM and is facing heightened competition from major software platform players such as ServiceNow, Salesforce, and Microsoft 2) New and emerging Gen AI solutions are putting constant pressures on the appeal of legacy RPA market and tools 3) Highly dilutive SBC structure in addition to an increasingly uncertain end-state FCF profile makes owning PATH an increasingly difficult proposition for equity holders. 

1) PATH appears to be almost tapped out in its RPA category TAM and is facing heightened competition from major software platforms expanding in many vectors

In the most recent CY Q1’24 quarter, management guided down its CY’24 midpoint revenue to $1.4B, implying +6% YoY growth (vs. prior guidance of $1.55B and +19% YoY growth). In addition, with the guided non-GAAP EBIT margin of ~10% in CY’24, PATH’s rule of 40 score is expected to fall steeply, becoming a rule of <25 company in ‘24E (vs. rule of 41 in ‘23A). One clear-cut sign of the company’s growth struggles can be seen in its sales efficiency measured by the magic number, shown below: 

Note: Magic number defined as new ARR divided by average of S&M spend of rolling 3 quarters

At just ~0.3x magic number, PATH has been unable to grow its ARR proportionally to its massive S&M spending, citing "increased deal scrutiny" and elongated sales cycle since late 2023. For reference, a healthy magic number would be around ~1x or higher. Looking at its total logos, there has been a complete slowdown and net churn in total customers since Q2’23 with signs of increasing logo churn starting 2024 and 2025. 

PATH total customers over time: 

Even though management indicates that their customers are seeing higher prioritization of using automation software to drive productivity and reduce costs, PATH has not appeared to be a beneficiary in deal materializations. In fact, PATH has seen NDR fall rather than pick-up with recent trends in increased enterprise AI adoption (from ~145% in Q4’21 to ~118% in Q1’24).  

One driver of apparent challenges lies in its existing competition. Outside of the comparable RPA vendors (e.g., Blue Prism, Automation Anywhere) and smaller point solutions, PATH has faced heightened challenges in growing its ~30%+ RPA market share (per Gartner) as enterprise platform incumbents have continued to not only build out their RPA offerings but also bolster their vertical AI workflow automation suites. Note that these platforms already benefit from the scale of distribution (e.g., logos count) and are the very environments where many of PATH’s RPA tools are used to begin with. 

To provide a few examples: 

ServiceNow (“NOW"): RPA Hub is already powerful in IT service management (“ITSM”) and NOW is moving broadly towards end-to-end enterprise workflow automation. RPA Hub and Process Automation Designer (“PAD”) already have integrations and connectors with many apps outside of NOW. Further integration with Now LLM and domain-specific small language models opens additional enterprise AI workflow automation use cases, with a focus today on end-to-end customer service, ITSM, HR, and finance workstreams. NOW works with Hugging Face and its internal teams to develop curated enterprise models. 

• Quote from Bill McDermott, CEO of NOW, from the Q2’24 earnings call: “Our GenAI strategy is focused on infusing intelligence into the flow of work, end-to-end across the enterprise, every department, every persona. With our native integrations, we already help people orchestrate across different systems and data sources. Now we can train the machines to do the low-value work so the people can up-level to the knowledge work.” 
• NOW acquired Intellibot, an RPA company in Q4’23, marking a push into AI-enabled RPA features such as ML and natural language processing to simplify deployments and enhance automation. 

Salesforce: Salesforce’s latest AI platform, Einstein, is deeply integrated with Salesforce ecosystem, offering out-of-the-box AI capabilities and a natural language task assistant for users. The Einstein Automate suite integrates with MuleSoft RPA and a host of other tools that enables AI driven automation of RPA-related tasks in the enterprise. 

These examples showcase the urgency and clear priorities for large software platforms such as NOW and Salesforce to integrate AI and Gen AI in their workflow automation products as well as RPA suites for customers, further reducing the need for or completely displacing the ROI of separate RPA software to achieve similar outcomes. Note that all these RPA platforms offer API integrations outside of their environments, providing extensive coverage across multiple software platforms (i.e., cross-compatibility is not just unique to PATH). 

For example, in a world where manual CRM processes are further simplified, completely automated, or supplemented with Copilot features, customers will broadly see fewer RPA uses cases. New native AI automation products and tools within major software platforms are already starting to take meaningful share and stymie growth for the vendor agnostic RPA market. 

2) New and emerging Gen AI solutions and platforms represent a whole new class of competitors that will put new pressures on the legacy RPA tooling market 

When compared to new and emerging Gen AI agent-based systems, RPA technology and the software architecture are significantly limited by its rigidity, scope, and scalability issues. Massive complexity arises if many bots are added, resulting in systems that become sprawling and difficult to manage. RPA is effectively a way to automate repetitive tasks following a specific instructed logic and does not handle complex processes or adapt to changes, almost always requiring a “human-in-the-loop” at various junctures. This is a different approach to a natively Gen AI agent-based architecture, which has clear advantages in i) semantic adaptability to handle unstructured and structured data and ii) contextual understanding of various environments, increasing the scope of the use cases of AI process automation in an enterprise. 

There are numerous early-stage companies that are working on such large action model (“LAM”) problems with commercial traction. Interestingly, PATH completed a de minimis minority investment in H Company, a foundation LAM startup that has raised significant capital to date and is a direct long-term competitor to PATH. Even more adjacently, horizontal enterprise Gen AI platforms such as OpenAI, Elastic, and Glean have stated their early intentions to provide AI apps and agents to address workflow automation. 

The management team and the industry have broadly pushed towards painting a rosy picture of RPA being a Gen AI beneficiary as a complimentary and an additive solution. More realistically, this is probably not the case, and the best-case scenario may still be slightly or moderately negative to market growth, as evidenced by decelerating growth metrics since mid-2023.  PATH is expected to launch a copilot solution Autopilot GA starting in June; however, this is more of a supplemental feature rather than a change to the core architecture. PATH management themselves state: “AI is creating a little bit of confusion with our customers, and they are evaluating what kind of tasks are better suitable to automate [with] AI [and] what tasks are better [with the UiPath platform]” 

PATH NDR continues to decline: 

With new Gen AI native startups, RPA players will likely see greater commoditization and pricing pressures driven by a completely new competitive set going forward. More companies are working to address the same set of problems, and enterprise customers will engage in elongated RFP processes, undercutting ACVs and pricing power of these vendors. Notably in the recent earnings call, management observed “changes in customer behavior, particularly with large multiyear deals”. This is a dynamic that is very real today and will only continue to grow over time for PATH. 

3) PATH operates a highly dilutive SBC structure and now faces an increasingly uncertain end-state FCF profile, making PATH shares a difficult proposition for equity holders  

PATH is expected to incur ~$528M in SBC in ‘24E, implying a whopping ~37% of revenue. At a ~$6.9B implied equity value at ~$12/share, shareholders face a sizable ~8% annual dilution to their shares. Worse, PATH’s path to GAAP profitability is now under limbo given the need to again revamp its S&M and R&D strategy. 

PATH will be forced to innovate, and management has indicated increased R&D expenditures to create and compete on AI driven products and features, a key rationale for the recent RIF. Near term, R&D as a % of revenue will likely be elevated to the 20-25%+ range with an uncertain payoff. GAAP FCF remains elusive especially given the massive SBC levels. PATH’s challenged growth and profitability algorithms in addition to SBC levels make investing in the shares a difficult proposition for most shareholders who are targeting a risk-adjusted return with upside predictability. 

Financials and Valuation:

PATH’s recent stock price underperformance has reduced its valuation multiples. At the same time, PATH remains significantly more challenged than a typical “show me” business given the setup of the massive go-forward competitive pressures. I believe PATH will have a difficult NTM period achieving not only the growth but also profitability targets set by management and the Street.

The company will need to demonstrate a turnaround to achieve the Street case, which appears optimistic in context of current developments in the market: 

The Base case assumes a scenario where growth remains challenged due to competition and increased need for R&D expenditures:

At ~$12/share, PATH is currently trading at multiples of ~3.3x NTM Street Revenue and ~28x NTM Street with a ~12% NTM growth and ~12% EBITDA margin profile. The market has largely penalized low-growth (<10% growth) SaaS companies, which trade at ~2-4x NTM Revenue.  

Based on a ~1.7x ‘25E Revenue and ~61x ‘25E EBITDA multiple, PATH can trade down to <$7.0/share in the event of a weaker than expected performance in the next several quarters. This represents a ~41% IRR on a 1-year price target. The analysis assumes additional share dilution from the impact of SBC at current trading levels.   

Risks:

1. PATH closing several large contracts in one quarter, allowing a short-term ARR beat in that quarter
2. Recovery in NDR and signs of cohort reacceleration 
3. Rebound in the EU market (~30% of ARR), which has remained broadly challenged on macro
4. Potential acquisition by Microsoft, which is unlikely given MSFT acquired Softomotive in ‘20A to build low-code RPA, and no real synergies would exist in an acquisition of PATH. An M&A outcome will likely occur under a <$2B TEV range 
5. Autopilot product sees significant traction and rebounds NDR 

Catalyst

Catalysts

• Continued deceleration in NDR or reduction in GDR (logo churn)
• Another downwards revsision 
• Higher than expected R&D spend 
• Continued deterioration in magic number and sales efficiency