DAVA - Endava: Demand Is Still Going Strong

Summary

• Technology adoption is going to be a necessity by default in the future.
• DAVA has a unique business approach.
• I expect DAVA to continue growing at a fast pace moving forward, especially as the latest quarter result showed strong demand momentum.

Summary

I see a 48% upside to Endava ( DAVA ). I believe DAVA is poised for sustainable high growth with increasing demand for its services from existing clients and the expansion of their businesses. With its Distributed Enterprise Agile approach, DAVA integrates with its clients' teams and provides its own Agile scaling framework, TEAS, to scale its services effectively. In addition, the company has a high client retention rate, and its revenue is primarily generated from fast-growing industries such as banking and IT. That aside, with a nearshore delivery model, DAVA is also able to better communicate with clients, strengthening relationships and meeting their needs.

Company overview

DAVA offers software engineering, cloud transformation, test automation, technology consulting, and other related services.

Technology disruption

The competitive landscape in every sector is shifting as a result of the waves of technological change. Digital native companies have flourished because they have been able to fully integrate new technologies into their operations. These businesses are known for their agility, creativity, focus on data and analytics, and dedication to the user experience they provide. Customers now have more options than ever before in terms of where, when, and how they receive the goods and services they purchase online. In order to keep up with their customers' ever-changing expectations and compete with newcomers who were born with digital technologies, established businesses must undergo a digital transformation and use technology to their advantage.

In order to keep up with their customers' ever-changing expectations and compete with newcomers who were born with digital technologies, established businesses must undergo a digital transformation and use technology to their advantage. However, incumbent businesses have typically entrusted technology development projects to more conventional IT service providers. When it comes to IT, the standard service provider is optimized for low-priced engagements in areas like integration and maintenance. Their expertise in legacy systems and ability to scale up their infrastructure mean they can successfully complete large-scale projects. Even though some of these more conventional IT service providers have made investments in user experience strategy and design and Agile development capabilities, their primary focus and historical expertise lie in supporting and maintaining offshore delivery of legacy systems.

DAVA approach

When it comes to providing cutting-edge technology services, DAVA is at the forefront of the industry. DAVA helps their customers find innovative approaches to user interaction, allowing them to better engage with their audience and respond to their needs.

With Distributed Enterprise Agile [DEA], DAVA works hand-in-hand with its customers to facilitate team integration, inspire new ideas, and implement them successfully. In order to provide DEA at scale, DAVA created its own Agile scaling framework called TEAS. The limitations of traditional Agile development methodologies prevent them from preserving agility at large scales when it comes to industrialized scaling. TEAS is an improvement on standard Agile scaling frameworks that allows for timely product releases without sacrificing quality. DAVA's goal in creating TEAS is to give teams just enough structure to feel comfortable taking on client challenges, while also allowing for enough wiggle room that they can adjust to the ever-changing nature of those needs. TEAS enables teams to quickly create, build and evaluate digital products, providing clients with valuable information on their potential value and business impact. This also speeds up product release, enables agile response to market changes, and integrates user and customer feedback more effectively.

Overall, I think DAVA helps its clients become more interactive, responsive, and efficient in their product and service delivery by providing user-centric digital strategies and engineering expertise. When it comes to building relationships with its customers and delivering value, I believe DAVA is in it for the long haul because of the way it works with its customers to learn about their business and their needs before integrating itself seamlessly into their teams. This has result in an important benefit: High client retention rate. This translates to more opportunities for upselling any new products and services. As this opportunity stream comes with very little customer acquisition cost, I expect them to carry high incremental margin. I think DAVA average spend from its top ten clients is a clear indicator of how important building a long-term relationship is.

Global distribution model

In my opinion, DATA can provide its customers with better technology services because it has developed a scaled global nearshore delivery model with selective close-to-client capabilities. By utilizing nearshore delivery locations, DAVA is able to better communicate with clients, strengthen relationships with them, and speed up responses so that they can better meet their needs. Consequently, DAVA will set itself apart through its work on projects that call for intensive participation from clients and iterative improvements.

Sustainable high growth moving forward

When thinking about the company's long-term health, I also consider the company's client exposure to be positive. About 77% of DAVA's revenue comes from fast-growing industries like banking and IT. DAVA is well-positioned to reap the benefits of rising demand for digital engineering and transformation services, particularly in the financial services and TMT sectors. This is because these industries are pioneers in this space, and their clients are increasingly looking to modernize their IT infrastructure in order to boost front- and back-office efficiencies, broaden their growth prospects, and enhance the quality of their customer service.

In my opinion, the majority of DAVA's future organic growth will come from the expansion of existing client businesses and project scopes as clients continue to increase their demand for DAVA's services. Most of DAVA's revenue has come from repeat customers over the past few years. The company has increased the number of its customers with £1 million in revenue to 140 in 1FQ23, from 46 in FY18, giving it a solid foundation on which to build future growth. DAVA, in my opinion, will be able to maintain its rapid rate of new logo additions (for comparison, DAVA added 47 logos compared to 1Q22) and will supplement its organic growth efforts with M&A to further expand and diversify the company.

Latest earnings result clearly indicates demand momentum

DAVA's 1FQ23 revenue increased by a healthy 25.9%, which was entirely organic. The growth was propelled by both higher spending from existing customers and the signing of brand-new accounts. The expansion was all-around, touching all of the company's main markets. Despite higher SG&A costs, the company's 40.4% gross margins were still very impressive thanks to rising prices. Overall, DAVA's revenue strength and margin leverage led to an EPS of £0.54.

Furthermore, management provided an optimistic outlook for the 2FQ23 and increased full-year guidance to account for the recent Lexicon acquisition, as well as robust demand and effective execution. Including the impact of Lexicon's 2% contribution, DAVA anticipates second-quarter revenue of £204.2 million to £206.5 million, an increase of 29.4 percent to 30.7 percent year over year. After previously projecting revenue between £840 and £850 million for FY23, DAVA has increased that range to £843 to £852 million. The range of 23-24% Y/Y constant currency growth is maintained.

Valuation

I believe there is 48% upside for DAVA. Based on my estimates, I expect DAVA to generate ~$1.3 billion in revenue and ~$340 million EBITDA in FY25. Revenue growth will be driven by growing revenue per existing customer and also adding new logos. Likewise for margins, the high incremental margins from upselling customers should aid in boosting margins. In terms of momentum, DAVA did not show any signs of slowdown either - revenue grew 303 in the latest quarter.

Using the current forward EBITDA multiple of 17x, it implies that DAVA is worth ~$6 billion in enterprise value, which translates to $129 per share.

Risks

Concentration of revenue in large customers

While this has been profitable for DAVA as long as there is room to upsell these customers, and they do represent a steady flow of potential new business, any loss of these customers would have a significant impact on profit and loss.

Competition for skilled IT professionals

Attracting and retaining a sizable pool of exceptionally talented and skilled IT professionals is crucial to DAVA's continued expansion. It could have serious negative consequences for the company if it fails to recruit, develop, and keep enough IT experts on staff.

Conclusion

In my opinion, DAVA's high rate of growth is sustainable because of the rising demand for its services from both new and existing customers. In order to efficiently scale its services, DAVA employs a Distributed Enterprise Agile methodology, integrating with client teams and supplying its own Agile scaling framework, TEAS. In addition, DAVA's nearshore delivery model allows for increased two-way communication with customers, allowing the company to better serve its clientele.

To conclude, I believe DAVA is well-positioned to ride on this long-term secular trend of digital transformation.

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