GDYN - Grid Dynamics Seeks Industry Diversification To Reignite Growth

2023-05-17 11:16:03 ET

Summary

• Grid Dynamics published its Q1 2023 financial results on May 4, 2023.
• The firm provides digital transformation and other consulting services to companies in major regions worldwide.
• GDYN's revenue growth has flattened and operating losses are worsening as it seeks to diversify the industry verticals it serves.
• Until the company can achieve diversification to less cyclical industries and materially reduce operating losses, I'm Neutral [Hold] on the stock.

A Quick Take On Grid Dynamics

Grid Dynamics ( GDYN ) reported its Q1 2023 financial results on May 4, 2023, beating revenue and matching EPS consensus estimates.

The firm provides a range of IT consulting and related services to organizations seeking to improve their operational efficiency.

Company leadership is seeking to diversify its client base by industry vertical to less cyclical industries.

Revenue growth has stalled and operating losses have worsened in recent quarters.

I’m Neutral on GDYN until management can reignite diversified growth and meaningfully reduce operating losses.

Grid Dynamics Overview

San Ramon, California-based Grid Dynamics was founded in 2006 to provide digital transformation consulting and related services to companies and other organizations worldwide.

The firm is headed by CEO Leonard Livschitz, who was previously president and CEO at LUXERA and VP of Marketing & Business Development at LedEngin.

The company’s primary offerings include the following:

• Digital transformation

• Technical consulting

• Software design, development, testing

• Internet services operations

Grid acquires customers through its direct sales and business development efforts and through partner referrals and word of mouth.

Grid Dynamics’ Market & Competition

According to a 2021 market research report by 360 Market Updates, the global market for digital transformation strategy consulting was an estimated $58.2 billion in 2019 and is forecast to reach $143 billion by 2025.

This represents a forecast CAGR of 16.2% from 2020 to 2025.

The main drivers for this expected growth in IT consulting are a large transition from on-premises, legacy systems to cloud-based environments with complex architectures.

There is also expected growth in the number of industries adopting digital transformation strategies, such as manufacturing, finance, and retail, as well as a growing demand for improved customer experience.

Also, the COVID-19 pandemic has likely pulled forward significant demand to modernize enterprise systems, resulting in increased growth prospects for digital transformation consultancies.

The growth of IT consulting is expected to continue due to the evolving digital landscape, increased demand for improved customer experience, the need to develop and maintain new or better business models, and the accelerated demand for modernization due to the pandemic.

Major competitive or other industry participants include:

• Globant (GLOB)

• Thoughtworks (TWKS)

• EPAM (EPAM)

• Slalom

• Accenture (ACN)

• Deloitte Digital

• McKinsey

• BCG

• Ideo

• Cognizant Technology Solutions (CTSH)

• Capgemini (CAPMF)

• Computer Task Group (CTG)

• Company in-house development efforts

Grid Dynamics’ Recent Financial Trends

• Total revenue by quarter has plateaued in recent quarters:

• Gross profit margin by quarter has trended lower more recently:

• Selling, G&A expenses as a percentage of total revenue by quarter have trended slightly higher in some quarters:

• Operating income by quarter has deteriorated well into negative territory:

• Earnings per share (Diluted) have worsened recently:

(All data in the above charts is GAAP)

In the past 12 months, GDYN’s stock price has fallen 49.37% vs. that of Computer Task Group’s drop of 26.5%, as the chart indicates below:

For the balance sheet, the firm ended the quarter with $258.4 million in cash and equivalents and no debt.

Over the trailing twelve months, free cash flow was $27.8 million, of which capital expenditures accounted for $6.0 million. The company paid a hefty $65.6 million in stock-based compensation in the last four quarters, the highest amount for the last eleven quarters.

Valuation And Other Metrics For Grid Dynamics

Below is a table of relevant capitalization and valuation figures for the company:

(Source - Seeking Alpha)

As a reference, a relevant partial public comparable would be Computer Task Group; shown below is a comparison of their primary valuation metrics:

(Source - Seeking Alpha)

Commentary On Grid Dynamics

In its last earnings call (Source - Seeking Alpha), covering Q1 2023’s results, management highlighted the ‘cautionary spending environment across industry verticals,’ as clients are likely to be cautious about spending due to slowing macroeconomic conditions.

On service delivery, the company has been scaling its operations, particularly in the APAC region in India and in light of its recent acquisition of Next Sphere Technologies.

The firm also expanded its cybersecurity services in the European market.

Management did not disclose any company, customer or employee retention rate metrics but stated that it did experience a 1.4% headcount reduction sequentially due to ‘rationalizing our non-engineering headcount.’

Total revenue for Q1 2023 rose 12.2% year-over-year, while gross profit margin dropped 1.8 percentage points.

SG&A as a percentage of revenue grew by five percentage points and operating losses continued to worsen.

Looking ahead, management seeks to diversify its customer base in order to drive sustainable growth and reduce dependence on fewer industry verticals.

The company's financial position is strong, with ample liquidity and no long-term debt. The firm generates material positive free cash flow.

Management did not provide full-year 2023 guidance but said that Q2 revenue should be $77 million at the midpoint of the range or essentially flat year-over-year.

Non-GAAP EBITDA is expected to be $10.5 million at the midpoint.

Regarding valuation, the stock is currently trading at an EV/Revenue multiple of 1.2x and an EV/EBITDA multiple of 0.

The primary risk to the company’s outlook is the continued slowing of macroeconomic conditions in a number of the company's key markets and industry verticals.

From management’s most recent earnings call, I prepared a chart showing the frequency of key terms mentioned (or not) in the call, as shown below:

I’m most interested in the frequency of potentially negative terms, so management cited ‘Recession’ twice, ‘Uncertain’ five times and ‘Macro’ four times.

The negative terms refer to the challenges the company faces in a weak macroeconomic environment where clients are scrutinizing buying decisions or delaying them.

In the past twelve months, the firm's EV/Sales valuation multiple has dropped from a high of 4.9x to 1.12x, as the chart from Seeking Alpha shows below:

In sum, GDYN’s revenue growth has largely stalled and the firm is generating increasing operating losses, a distinct negative in the current rising cost of capital environment.

Until management can meaningfully diversify its industry verticals and generate revenue growth while reducing operating losses, I’m Neutral [Hold] on GDYN.

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