DAVA - Endava

[Broeb22]

Does anyone have a view on Endava?

 

They are an IT outsourcer that is a little bit more differentiated than the India-based outsourcers. Their workforce is mostly Eastern European, and some of the best programming talent globally comes out of this area.

 

S/O: 54.5MM

Stock Price: $26

Market Cap: $1.4BN

Forward EPS: $0.91 USD (They report in GBP)

Forward P/E: 28.6x

2020 Est. P/E: 22.0x

 

40% Revenue Growth (probably 25% long-term) at Mid-Teens Margins with very high ROICs (>50%).

 

While valuation on this year's P/E seems high, it is not much higher than other high ROIC, but lower growth companies out there.

 

The industry (a subset of IT outsourcing focused on programming) is growing at 20% per year right now, and likely has many years of 10% + growth going forward.

 

 

Their closest comps is EPAM and LXFT was recently acquired.

 

 

[cameronfen]

The elevator pitch looked interesting.  I think I'll take a look and report back my opinions.  I wasn't big on LXFT and others like them (including probably DAVA) because this seems like a commodity business.  However, my opinions on this are not strong and I think I could be convinced easily. 

[Guest Schwab711]

From my experience investing in SYNT and consequently becoming somewhat familiar with EPAM and LXFT, these businesses grow due to the FX/local wage fundamentals supporting the efficiency of the outsourcing location (tailwinds) more than anything to do with the actual business. The optimal location used to be India, right now it seems to be Eastern European countries, and maybe in the future it will swing back to India or some new country/region.

 

They look like good investments on paper and they work well until they don't because the underlying business dynamics can shift without being detectable until it's too late. I would try to figure out why Eastern Europe took over India as the optimal outsourcing location and figure out what would cause Eastern Europe to no longer be optimal. It's probably tracking FX and developer wages in the EU (probably with a focus on Romania but I couldn't quickly find where the majority of their offshore workforce is. Also, their largest customer is Worldpay UK Ltd, which could make them sensitive to whatever happens with Brexit.

 

I have no view on DAVA specifically, just offering my experience looking at names in the sector. The lower wage EU countries appear to be the optimal offshore IT location at the moment.

[Broeb22]

Can you give an example of underlying business dynamics changing before you can detect them?

 

As far as the industry tailwinds, there is a huge lack of programming talent in the Western world. I see these types of companies as a combination of labor cost arbitrage AND skills arbitrage. From what I have read, and a good write up was done by Kerrisdale on LXFT, the technical talent is higher in Eastern Europe than other traditional outsourcing destinations. A big piece of the Indian outsourcing business was really business process outsourcing, people answering phones, managing servers, back of house automation.

 

If it were all about cost, India is still very cheap. So I think there is more to these companies than it’s just the next cheap place to find techy labor.

 

 

[Broeb22]

https://www.kerrisdalecap.com/wp-content/uploads/2016/10/Luxoft-LXFT.pdf

[Jurgis]

Number-wise India programming labor pool is way larger than Eastern Europe's.

 

Quality-wise Eastern Europe's labor pool may be better, but best people have either emigrated to US/western EU or work for US/EU companies already. IMO finding a cheap quality team in EE is as hard as finding it in India. And if you find it, you'll have similar issues as with Indian teams. Not saying it's impossible, but it's not easy either.

 

Just my impression though. YMMV and all that.

[Guest Schwab711]

Can you give an example of underlying business dynamics changing before you can detect them?

 

As far as the industry tailwinds, there is a huge lack of programming talent in the Western world. I see these types of companies as a combination of labor cost arbitrage AND skills arbitrage. From what I have read, and a good write up was done by Kerrisdale on LXFT, the technical talent is higher in Eastern Europe than other traditional outsourcing destinations. A big piece of the Indian outsourcing business was really business process outsourcing, people answering phones, managing servers, back of house automation.

 

If it were all about cost, India is still very cheap. So I think there is more to these companies than it’s just the next cheap place to find techy labor.

 

See Jurgis' post and search "India" in the link. This is anecdotal but it gives an example of wage inflation, in India, for IT specialists.

 

https://news.ycombinator.com/item?id=18342996

 

At every point of the last 20 years, India still looked like the best place to offshore IT work. However, due to language, daylight hours, labor supply/demand, ect, it became profitable for more and more work to go to EE. It's hard to know where the value proposition bifurcates.

 

India has a massive pool of IT talent, as Jurgis mentioned. The big issue is they started demanding more money. It's a holistic, difficult-to-pinpoint intrinsic value that considers talent, language, normal working hours (to sync with the US/EU), and other factors. Where offshoring occurs will shift from EE to somewhere else at some point. I don't know when, why, or to where.

 

Don't take these opinions as absolute. There will always be some offshoring in India, EE, South America, ect. It's about 'business continuity' for large US multinationals. I'm just saying where increased offshore spending $ will flow will be based on a difficult to measure or track metric. I'm just trying to say that the business model will not have secular tailwinds forever. Arbitrage opportunities get arbitraged.

[Broeb22]

I guess that's what makes a market.