TWKS - Thoughtworks Is Acquisitive As Growth Challenges Loom

Summary

• Thoughtworks went public in September 2021, raising approximately $774 million in a U.S. IPO.
• The firm provides a range of IT consulting and related services to clients worldwide.
• TWKS has grown revenue but is producing losses as the global economy slows and some of its clients are having funding access challenges.
• I'm on Hold for TWKS in the near term.

A Quick Take On Thoughtworks

Thoughtworks ( TWKS ) went public in September 2021, raising approximately $774 million in gross proceeds from an IPO that priced at $21.00 per share.

The firm provides a wide range of IT consulting services to clients worldwide.

Given Thoughtworks’ apparent high valuation and growing growth challenges ahead, I’m on Hold for TWKS in the near term.

Thoughtworks Overview

Chicago, Illinois based Thoughtworks was founded to develop a set of competencies to enable enterprises to evolve and modernize their IT and digital infrastructures for their business goals.

Management is headed by Chief Executive Officer Guo Xiao, who has been with the firm since 1999 and previously worked in numerous roles within the company and its subsidiaries.

The company’s primary offerings include:

• Enterprise modernization

• Customer experience

• Data and AI

• Digital transformation

The firm seeks consulting and integration relationships with enterprises via its direct sales & marketing efforts as well as through partner relationships.

Thoughtworks’ 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 of16.2% from 2020 to 2025.

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

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

Major competitive or other industry participants include:

• Globant (GLOB)

• EPAM (EPAM)

• Slalom

• Accenture (ACN)

• Deloitte Digital

• McKinsey

• BCG

• Ideo

• Cognizant Technology Solutions (CTSH)

• Capgemini (CAPMF)

• Company in-house development efforts

Thoughtworks’ Recent Financial Performance

• Total revenue by quarter has risen according to the following chart:

• Gross profit by quarter has fluctuated in recent quarters:

• Selling, G&A expenses as a percentage of total revenue by quarter have varied as the chart shows below:

• Operating income by quarter has been significantly negative in the past four quarters:

• Earnings per share (Diluted) have remained negative as shown here:

(All data in above charts is GAAP)

In the past 12 months, TWKS’s stock price has fallen 55.5% vs. the U.S. S&P 500 index’ drop of around 11.9%, as the chart below indicates:

Valuation And Other Metrics For Thoughtworks

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

(Source - Seeking Alpha)

Compared to the IT Consulting & Other Services industry average EV/Revenue multiple of 1.76x, the firm is currently being valued by the market at a multiple of 3.61x, a significant premium.

While the firm posted trailing twelve-month revenue growth of 36%, the IT Consulting & Other Services index averaged 27.04%. So, the firm is being valued by the market at around twice the industry average in spite of revenue growth being only slightly higher.

Commentary On Thoughtworks

In its last earnings call (Source - Seeking Alpha ), covering Q2 2022’s results, management highlighted an important differentiator in that the business is diversified across various industries and geographies.

The company provides consulting for digital transformation, data and AI, cloud, customer experience, platforms and product and design.

Notably, management has supplemented its organic growth efforts with targeted acquisitions. The firm announced its second 2022 M&A deal for a strategic design consultant firm in Brazil with 50 employees, giving the company an increased presence in Latin America.

The company also recently became an AWS Premier Services Partner, which management said is the highest partnership tier and ‘less than 3% of AWS partners achieve this status.’

As to its financial results, total revenue rose by 27.5% year-over-year, or 33.5% in constant currency terms.

Adjusted EBITDA grew by 14.2% with a 17.6% margin that was above previous guidance although lower than 2021’s figure.

Adjusted gross margin dropped to 40.6% from 43.5% in Q2 2021, while adjusted SG&A was flat year-over-year.

EPS losses continued to be impacted by employee stock compensation, which dilutes shareholders in the process.

For the balance sheet, the firm ended the quarter with cash of $275 million, higher by $59 million year over year. Debt dropped by $100 million to $406 million at the end of July.

Looking ahead, for the full year 2022, management expected revenue to rise on a constant currency basis by approximately 30% at the midpoint.

Adjusted EBITDA margin is forecast to be around 19.5% at the midpoint, similar to previous guidance in May 2022.

Regarding valuation, the market is valuing TWKS at a fairly high valuation compared to the overall IT consulting market.

The primary risks to the company’s outlook are a combination of slowing macroeconomic conditions, reduced funding available to private technology companies and currency impacts on its bottom line.

While management may choose the period ahead to be more active in acquiring consulting firm targets which will serve to grow revenue inorganically, that strategy may obscure a more challenging organic revenue growth picture.

Given Thoughtworks’ apparent high valuation and growth challenges ahead, I’m on Hold for TWKS in the near term.

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