Description

Background

Endava plc (DAVA) is a London, UK based IT solutions company who are hired on an outsourced basis as project developers and designers for digital transformation, AI implementation, and data modernization projects across verticals including payments, financial services, and TMT.

Between 2016-2023, DAVA grew revenues >30% on average. For FY’24 (which was reported on 9/19) DAVA revenues declined (6.8%), the result of the lower IT spend environment, an elongated planning cycle (particularly for AI projects), and a weaker macro backdrop. Even with the lower spending environment DAVA has been FCF positive (most recently reporting £58.4 in FY’24 with the last peak being ~£140 MM in FY’22).

Companies are starting to understand how difficult it can be to implement value-adding AI services for their businesses outside of using simple chatbots and getting Chat GPT subscriptions. For companies who want to add AI that utilizes their existing data lakes, the data must first be cleaned and modernized so it can feed into AI processes. That is where DAVA comes in. DAVA has decades of experience in data modernization and digital transformation. Since the rise of AI, DAVA has been contracted for multiple AI-implementation projects across an array of industry verticals. They have differentiated expertise in this domain and are positioning themselves as the first-choice service for those looking to spearhead their company’s transition to AI.

Why is now the right time? Shares have largely been washed out following two years of growth/macro headwinds (following a period of rampant IT spending during and post-COVID). The company is expected to return to growth this year and management has stated they are guiding to a (what they say is a conservative) 10-11.5% c/c revenue growth rate year over year (which would have been ~2.5% higher if not for FX considerations). This guidance does not factor in pricing improvements, nor does it account for any improvements in customer IT budgets. When you factor in cross sale opportunities (which DAVA is already experiencing from their GalaxE integration), budget improvements, and AI project planning becoming AI project implementation, we believe DAVA has plenty of room to run through 2025 and can return to >20% growth.

Slower IT spending and a weakened outlook drove DAVA shares from ~$165+/share in late 2021 to under $30/share today. We believe DAVA is currently underappreciated. There are signs of an oncoming upcycle in IT spending on the horizon, driven in part by AI project starts and necessary data modernization, while the DAVA diversifies into new verticals to not over index themselves to one industry and better capture increased spend broadly.

Key Considerations

DAVA benefits from AI spending as the company a) is focused on new project development as opposed to existing project maintenance (which is more common with competitors) and b) has a key competency in data modernization, which is a core foundation for AI projects

• For LLMs to operate efficiently, having homogenous data is a critical foundation. DAVA offers data modernization for their clients (taking legacy datasets and converting them into more consistent, feedable data for LLMs/AI use) – effectively step one in building AI capabilities for a customer
• Management highlighted on 4Q earnings that customers are becoming increasingly aware that AI implementation is a complex and lengthy process – with that, DAVA’s core competencies in project planning, data modernization, and implementation positions them to win as customers ramp their AI project spend
  • On top of core business operations, this increase should drive the >10% revenue growth we expect for 2025+ (and 20%+ once AI projects move from the planning phase)
• Legacy IT service providers have been more concentrated on picking up / continuing maintenance projects while DAVA has a greater concentration of new project planning and implementation, which levers them into an IT spend upcycle particularly for those customers with plans to spend more on AI/machine learning

IT spending is set to return in the coming years and lower interest rates are helping facilitate this shift. DAVA should be well positioned to grow >10%/year as a result of improved spending and >20%/year once AI projects exit their respective planning phases.

• Focusing on the payments sector (DAVA’s largest revenue contributor in FY’24), recent CFO surveys have pointed to IT departments expecting to allocate 10-20% of budgets to AI/Machine Learning (as reported by Citi) while software budgets are simultaneously expected to increase overall (~LSD% expected)
• Currently, sales cycles for AI work have been elongated as CEOs/CFOs are more hesitant to sign deals after the COVID-related spending boost. Management teams now require more planning before implementing projects, especially when it is for a new technology (such as AI)
• The addressable market for digital transformation investments (inclusive of AI-driven data modernization projects) is growing and expected to reach ~$3.9 Tn by 2027 (or a ~16.1% annual CAGR)
• While obvious, lower interest rates ease the borrowing environment (particularly for mid-market and non-enterprise customers) and should drive incremental opportunities for DAVA as customer budgets grow
• From a regional standpoint, key European countries will have completed their local elections by the start of DAVA’s FY2H’25 (along with the US), which we expect will give companies more confidence in setting their budgets for calendar 2025 – improving DAVA’s earnings visibility (which has been blurred in recent quarters)
• Additionally, lapping the acquisition of GalaxE (which added some North America exposure) will add to DAVA’s organic growth measure and improve screening (though we are cognizant of potential integration noise)

DAVA has historically been concentrated across a few key verticals including payments, financial services, and TMT but the company is expanding into consumer products, healthcare, mobility, and retail.

• The payments vertical is also set to benefit in the meantime as lower interest rates have historically led to higher volumes in the sector – which in turn should facilitate increased IT spend budgeting
• While the outlook for payments improves as interest rates decrease, DAVA’s entry into additional verticals as discussed by management presents the opportunity for further backlog growth opportunities through 2025 and a growing earnings base
• Additionally, expansions into new regions and verticals should smooth the cyclicality for DAVA forward earnings, making results and guidance more consistent

Valuation

• Assuming a conservative HSD-LDD% revenue growth through 2031 and stable EBITDA margins, we believe DAVA can continue to generate positive FCF into/through the IT spend upcycle and trade north of $60/share (vs. mid-20s/share today). Winning more AI projects and experiencing faster project approvals from customers (effectively exiting the planning phase) would drive incremental improvements to our PT.

Catalyst

Catalysts

• Customer IT budget announcements
• Continued AI spending
• Continued customer need for data modernization as a foundation to AI projects
• Returning to 20%+ growth following the above listed catalysts