DAVA - Endava: Agile Innovation In A Digital Era

2023-12-29 10:56:30 ET

Summary

• Endava is set to outgrow the IT sector as a pure-play digital service provider amid widespread digital transformation.
• Endava's agile development and expansive engineering talent enable it to manage complex, high-value digital projects globally.
• Specializing in cutting-edge technologies, Endava has a strong presence in Payments, Financial Services, TMT, and Mobility, contributing to its revenue.
• With a strategic focus on continuous innovation, Endava's service offerings cover defining, designing, building, and evolving digital solutions.
• Despite risks from macro-sensitive sectors, Endava's robust capital and acquisition strategy position it for growth and client diversification.

Endava ( DAVA ) is positioned as a long-term winner in the IT services sector, poised to benefit from the ongoing digital transformation trend. The company's focus as a pure-play digital provider is expected to drive outsized growth compared to the broader IT services market. Endava's involvement in rapidly growing economic sectors facing significant technological changes further underpins this growth trajectory.

Endava's Business Model

Established in 2000 and headquartered in London, England, Endava is a prominent digital IT sector player. The company excels in catering to clients whose development needs surpass the capabilities of their internal technology teams-a scenario increasingly prevalent due to the growing complexity of technology. Endava's approach is rooted in agile development, emphasizing rapid idea iteration to enhance usability and market readiness, which it successfully implements globally.

Endava harnesses its extensive global engineering talent to help clients implement modern technologies to achieve their business objectives. The company is a committed advocate of agile development, boasting a robust capability in steering projects from the initial proof of concept to full production. Central to its business model is a focus on high-value digital projects, with outsourced software engineering forming the core of its value proposition.

Endava's engagement with clients spans many technologies, encompassing current (like mobile, social media, automation, platform development, data analytics, and cloud delivery) and future-oriented technologies (including IoT, AI, ML, and AR/VR). A formidable array of engineering talent, internal software assets, and other intellectual property backs this diverse technological involvement.

Agile development, a cornerstone of Endava's approach, is integral to the company's technological endeavors. Recognizing the fast-paced evolution of the IT landscape, Endava invests in innovation-forward initiatives such as innovation labs, monthly insights sessions, and competitions to maintain its edge in a rapidly changing environment.

Regarding revenue generation and domain expertise, Endava predominantly focuses on Payments and Financial Services ('PFS'), contributing significantly to its revenues. Additionally, the company has considerable involvement in Telecommunications, Media, Technology ('TMT'), and Mobility. Endava benefits from learning from its client relationships in these sectors, leveraging this knowledge across verticals, enhancing its domain expertise, and bolstering its growth potential.

Endava's technological contributions are extensive, particularly in the payments ecosystem, where it has developed merchant acquiring platforms, payment processing platforms, e-commerce gateways, mobile wallets, and more. The company has made strides in developing trading and settlement systems and automating claims, underwriting, and pricing processes in the financial services sector. Endava's TMT projects include solutions for connected homes and cars, automated purchasing solutions, and 5G-enabling technologies. The company also maintains significant client relationships in mobility, healthcare, industrial, retail, and consumer goods sectors.

Lastly, Endava's robust capital generation and low leverage allow it to pursue strategic bolt-on acquisitions that complement its existing business, focusing on minimizing integration risks. The company's recent investments to expand its footprint in the Asia-Pacific region are a testament to this strategy. Endava anticipates that acquisitions will contribute an additional 2.5% to 5.0% to its FY24 revenue, and any outperformance from these acquisitions could provide an upside to the company's projected financials.

Business Mix

Endava's business mix, encompassing service, geographic, and vertical mixes, is a crucial aspect of its operational strategy.

Service Mix

Endava's service offerings are structured into a cohesive four-part flywheel that promotes continuous transformation and innovation: Define, Design, Build, and Run and Evolve.

The company's Define and Design services are advisory and often serve as the starting point for building long-term client relationships. Endava helps clients capitalize on new business models and market opportunities by formulating dynamic digital platforms and experiences. Their teams focus on business analysis, data and analytics, and digital product strategies, setting the foundation for clients' digital journeys and ensuring alignment with their long-term objectives.

In the design phase, Endava crafts intelligent digital experiences through architecture, extended reality, machine learning, AI, product design, user experience ('UX') design, and visual design. Endava's world-class engineering capabilities come to the forefront in the build phase. They specialize in automated testing, cloud-native software engineering, and continuous delivery, enabling the creation of the platforms and solutions conceptualized in the Define and Design stages.

Lastly, the Run & Evolve stage focuses on the ongoing management and enhancement of applications and infrastructure. This includes agile applications management, cloud infrastructure, DevSecOps, service delivery, smart desk, and telemetry & monitoring. Endava ensures that clients' digital solutions remain cutting-edge and evolve with the market, thereby driving fundamental transformation.

Endava integrates these capabilities to rapidly drive transformation, leveraging the synergy between product strategies, intelligent experiences, and engineering excellence to make clients more engaging, responsive, and efficient. The intersection of these services allows Endava to create meaningful and sustainable change for their clients.

Geographic Mix

Endava reports its revenue across four geographical segments: the UK, the US, Europe (excluding the UK), and the Rest of the World ('RoW'). Historically a Europe-dominant firm (with revenue exposure reducing from 73% in FY19 to 60% in Q124), Endava has seen growing revenue contributions from the US. However, its peak at 35% in FY22 has since reduced to 30% in its most recent earnings. The RoW segment, particularly the Asia-Pacific region, presents a significant growth opportunity. Recent acquisitions in the Asia-Pacific region have increased RoW's revenue contribution to 10% in Q124.

Vertical Mix

Endava's expertise lies in verticals experiencing rapid technological disruption. Traditionally, its vertical reporting was split into Payments and Financial Services ('PFS'), Tech, Media, Telecom ('TMT'), and Other. The company has since refined its reporting to better represent its PFS exposure across Payments, Banking and Capital Markets ('BCM'), and Insurance and to distinguish Mobility from Other. Endava's strong presence in PFS, with robust relationships with major players, positions it as a dominant player in the market. However, as of Q124, both Payments and BCM segments saw double-digit year-over-year declines, indicating challenges for near-term growth. Insurance, in contrast, showed a significant increase, while TMT saw a slight decrease, and Mobility and Other experienced growth.

Customers and Competitors

Endava operates in a competitive landscape populated by diverse global players. Its primary competitors include pure-play digital IT service providers, such as peers such as EPAM Systems ( EPAM ), Globant ( GLOB ), and Thoughtworks ( TWKS ). Additionally, they face competition from established traditional IT services providers like Accenture ( ACN ) and Capgemini SE ( CAPMF ). Key differentiators in this space encompass the capacity and quality of engineering talent, technical and vertical expertise, comprehensiveness of solutions, delivery locations, pricing, responsiveness, and overall marketplace reputation.

As of Q124, Endava reported having 716 active clients, defined as those who have paid for services in the last 12 months. Endava's client base primarily consists of European and American companies in the payments, financial, and technology sectors. Notable clients include Mastercard, Worldpay, and Global Payments in Payments and Financial Services ('PFS'); Adobe, BBC, and Cisco in Tech, Media, and Telecom ('TMT'); and Maersk in other sectors. Endava's engineering services are integral to its clients' core operational and strategic initiatives, such as developing new international payment gateways.

While the company does experience some degree of customer concentration, with Mastercard accounting for 10% of sales, this level is considered reasonable compared to its peers. The company has been actively working to diversify its client base; its exposure to the top 10 clients has declined from 39% to 33% over the past five years. Endava is increasingly engaging with smaller clients with significant spending potential to reduce this concentration risk.

Risks

Endava's significant exposure to certain verticals sensitive to macroeconomic fluctuations presents a notable risk. As of Q124, its largest verticals - Payments, Banking and Capital Markets, and Tech, Media, and Telecom - comprised 64% of its sales. These sectors have shown economic sensitivity in recent years. For instance, a consumer-led recession could adversely impact global payment volumes. At the same time, a prolonged high-interest rate environment constrains technology companies' spending. Although such risks are not unique to Endava, its relatively high expected sequential growth rates potentially make its financial performance more vulnerable to these macroeconomic shifts.

Additionally, Endava has achieved commendable success in penetrating the outsourced development spending of its largest clients. However, this high level of wallet share penetration may limit future growth opportunities with these clients. Over time, its top clients might face limited incremental spending to allocate to Endava. Consequently, revenue growth from these accounts may depend mainly on the overall IT spending of these clients, which is still being determined, especially considering the current focus on operating leverage and earnings growth in a high-interest-rate environment. Endava must increasingly leverage its extensive portfolio of smaller clients to sustain growth. This could prove more challenging than replicating its success with larger clients, requiring strategic adjustments and potentially involving different market dynamics.

Valuation

As discussed earlier, Endava's peer comps closely align with pure-play digital IT Services providers Globant, EPAM, and Thoughtworks. A broader peer set also includes non-pure-play digital or secondary peers, such as Perficient ( PRFT ), Grid Dynamics ( GDYN ), and CI&T ( CINT ). In theory, Endava should trade closely with its primary peer group, and the whole comp group supports the broader framework for evaluation.

Endava has a forward EBITDA multiple of 20.66x, higher than the primary peer group median of 13.36x and all peer group median of 15.93x. This indicates that Endava is valued more richly on a forward-looking EBITDA basis than its peers. Such a premium could suggest that investors expect higher growth, profitability, or stability or that Endava has unique value drivers not reflected in its peers. For instance, this could be due to its specialized focus on digital IT services, geographic presence, or client relationships.

While Endava's valuation is higher than its peers, which could imply higher expectations from the market, its gross margin is slightly below the peer median, suggesting there might be room for improvement or differences in business composition. Its EBITDA Margin, however, demonstrates operational efficiency, particularly when compared to its primary peer group.

Endava's implied share price indicates that shares are trading at a premium. The company is trading at $78.66, approximately 51% higher than the calculated implied share price based on the median EBITDA multiple of its primary peer group. This premium suggests that the market is pricing Endava shares more optimistically than the peer group median would imply.

Endava's future valuation could benefit significantly from successful execution against its FY24 guidance, notably if it outperforms its peers. Achieving top-tier growth could warrant a premium valuation multiple. Conversely, a guidance revision could offer an attractive entry point for investors, considering the company's favorable long-term growth prospects.

Investors may view the premium as justified based on the company's fundamentals and growth prospects or see it as an overvaluation relative to its peers. In either case, this analysis is essential to an investor's due diligence, informing decisions about buying, holding, or selling shares.

Final Thoughts

Despite inherent industry risks, Endava stands out as a robust investment opportunity. The company's adeptness at navigating the complex digital IT landscape, its agile development approach, and strategic expansion through acquisitions positions it for sustained growth. Endava's commitment to innovation, backed by a solid service offering across various high-growth verticals, underpins its potential to outperform in IT services. The premium on its shares reflects market confidence in its future, making it an attractive proposition for investors looking to capitalize on the digital transformation wave.

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