Description

Acquire Nagarro, an orphaned digital engineering company with a demonstrated history of ~20% organic growth, for 10x 2025E earnings and at a >50% discount to peers.  

Listed on the Frankfurt exchange and covered by few sell-side analysts, the business trades at a steep discount to US-listed peers EPAM and Globant while offering a similar financial profile with ~20% annualized growth and double-digit EBIT margins (net of SBC) during normal demand conditions. Nagarro has an entrenched recruitment and delivery base of IT professionals in northern India, sourcing employees directly from colleges and offering lower billing rates than peers. Simultaneously, this is a founder-led business that has delivered 20+% organic growth for many years utilizing an entrepreneurial, highly decentralized approach. Founder Manas Human owns 6% of the company and has expressed a desire to “write the book” on organizational design. We believe that growth returning to the industry in the coming year and an eventual shift to a US stock exchange will give Nagarro credit for its strong prospects and help close the discount. We see more than 100% upside should Nagarro achieve a peer valuation.

Nagarro provides digital engineering services to businesses globally, building applications and strategizing to solve clients’ technological problems. Between 2019 and 2021, digital transformation underwent significant growth with most providers growing 25 – 50% annually. As rates rose and recessionary concerns emerged, clients retrenched and revenues for digital engineering companies slowed dramatically. Nagarro grew 6.5% in 2023, slightly exceeding most public peers. Spend has been throttled, but the underlying market structure remains intact and Nagarro has maintained 98 – 99% client retention.

Unconventional, Orphaned Security: Since Nagarro spun-off from IT outsourcing company Allgeier SE in 2020, it has consistently been overlooked. Nagarro is one of the most unconventional companies we have come across – an Indian business listed in Frankfurt that has no headquarters, substitutes a ‘finance council’ for a CFO, and has few traditional CXO roles. Instead, the business is structured as Global Business Units (GBUs) led by their own entrepreneurs, Sales and Marketing Units (SMUs), and global Centers of Excellence (CoEs). While several major sell-side banks cover EPAM and GLOB, few sell-siders cover Nagarro with Jefferies being the most recognizable name. The co-founder and Custodian of Entrepreneurship in the Organization (as regular people would call it, the CEO) Manas Human is entrepreneurial, humble, extensively diligent, and not promotional in the slightest. While many investors may be deterred by this unconventional structure, we believe the company’s highly entrepreneurial culture confers competitive advantage, as reflected by superb client NPS scores and high employee retention and enthusiasm for the company.      

Advantaged Indian IT Recruitment: Underneath this arcane wrapper lies a growing operation that has longstanding relationships at major tier II colleges and their recruitment cells in northern India to consistently hire talent. Indian developers are significantly cheaper than EPAM’s European and GLOB’s Latin American IT professionals, giving Nagarro lower billing rates on the same projects. Nagarro has maintained high client satisfaction, as measured by their NPS and client feedback, as well as sticky existing client spend for those contributing >€1mm in revenue. We believe that the business currently has some embedded operating leverage and can expand EBIT (net of SBC) margins above current ~10% levels since Nagarro carried excess capacity through the demand slowdown and did not fire engineers like its peers did. As the business returns to growth, overhead is reduced, and salary increases are gradually passed through to clients with a timing lag, margins will likely converge on ~12 – 13%.    

Growth Resumption and Cyclical-low Valuation: Industry growth is expected to revert to its baseline by next year. Delayed / pipelined projects are converting with improving macro and resurging digitization use-cases. GenAI is viewed as a catalyst for client interest and newer projects are expected to pivot from the ‘hygiene spend’ of the last few years to the growth spend experienced between 2019 – 2021. We expect Nagarro to eventually grow high teens to ~20% as demand normalizes and believe that client projects are already headed in the right direction.

Between 2019 – 2022, Nagarro grew at ~28.5% CAGR while GLOB grew ~39% and EPAM grew ~28%. Nagarro maintained 11.2% clean EBIT margins during that period while GLOB had marginally higher 13.2% and EPAM 14.7% margins. Not bad. In 2023, Nagarro was resilient again with 6.5% growth and 10.2% margins while Globant grew ~18% (11% organically) with 11.7% margins and EPAM’s sales declined LSD with 13.2% margins. Again, not bad. Not bad + not bad should = not bad. However, the stock seems to price in little demand improvement and trades at a >100% discount to EPAM and Globant on 2025E SBC-adj. EPS.

Once demand normalizes, we assume the business grows ~14% in 2025 and can reach ~12% clean EBIT margin and €6.98 EPS or ~8% net margin. This implies that it currently trades at ~10x 2025E earnings while peers trade at ~25x earnings with EPAM at ~24.5x, GLOB at ~34x, and DAVA at ~16x. Nagarro should be worth 24 – 25x earnings, implying ~130 – 140% upside.

We believe the current valuation discount to peers is unjustified. Nagarro’s growth profile and earnings power is not meaningfully different from peers. The business is advantaged with the lowest price delivery from India in an increasingly cost-conscious demand environment that enables the business to perform competitively against peers.

Shifting Sales Culture, Trustworthy Management, and Potential US Listing: Nagarro has historically sourced clients through referrals and inbounds. While ‘farming’ existing accounts worked well during periods of high growth, CEO Manas Human intends to revive the entrepreneurial spirit in the organization by hiring ‘hunters’ who can aggressively source competitive projects and help Nagarro move into C-Suite boardrooms. A pivot in the direction of the sales force is promising and should position them competitively, heading into a period of resurging growth.

We find Manas and his team to be trustworthy, sound operators who have built Nagarro from the ground up. Additionally, former Allgeier CEO Carl Georg Dürschmidt is aligned with management and owns ~22% of the company. We believe that management is committed to improving shareholder value and will eventually consider a US listing, given the increasing focus on this client geography, which could help close the discount and offer further LT upside.

Catalyst

Earnings growth should be the most meaningful catalyst for the shares. The company has utilized share repurchases in the past and we believe they will ultimately consider a US listing if an appropriate valuation cannot be obtained on the German exchange. The company recently hired a US-based IR person for the first time.