PERFICIENT INC PRFT
October 30, 2022 - 3:55pm EST by
GLSV
2022 2023
Price: 66.71 EPS 4.28 4.81
Shares Out. (in M): 37 P/E 15.6 13.9
Market Cap (in $M): 2,445 P/FCF 0 0
Net Debt (in $M): 373 EBIT 200 225
TEV (in $M): 2,818 TEV/EBIT 14 12.5

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Description

I thought I would add a new name to the VIC library.  I believe this company is an underappreciated growth story that is now trading at a discounted valuation given macroeconomic concerns.  While economic sensitivity is not to be dismissed, if one is willing to take a multi-year view the current share weakness looks like an opportunity and favorable risk/reward.

Perficient is a small/mid-cap  IT services/consultancy firm which focuses on several key service verticals – strategy & consulting; data & intelligence; platforms & technology; customer experience & digital marketing; Innovation & product development; and optimized global delivery.  The company was founded in 1998 and is headquartered in St. Louis, MO.

More generically, the company develops solutions which enable clients to modernize their technology stack, positioning itself as an  enabler of digital transformation priorities including application development and systems integration.   While individual project engagements tend to be more short-term in nature (<1 year) providing some visibility to revenue; it is notable that on average the company’s top 50 client accounts have had a relationship with Perficient for 10 years.  The company’s strategy is to win projects within these accounts, then identify other client needs and selling additional technologies within those accounts. The result is average revenue from the top 50 clients has grown from about $3 million to over $8 million.  It is also noteworthy that more than 95% of revenue is derived from domestic clients; 93% of the business comes from customers who were customers in the prior year, and the business is reasonably well diversified across industry vertical (below) with the largest two being healthcare & financial services (~45% combined). 

The overall industry backdrop is favorable and supportive of the company growing at an above average rate.   Front-end digital transformation work has amongst the highest growth profiles within the IT services industry.  IDC estimates that these high growth areas can sustain a mid-teens trajectory over the next few years.   

 

Implications of the transition from onshore delivery to near- & off-shore

One key aspect to the Perficient story is the transition from onshore to nearshore (Latin America) and offshore (India) delivery.   Onshore delivery averages a mid-to-high 30% gross margin whereas offshore gross margins are in the low-50% range.  The obvious tradeoff is significant compression in the blended bill rate where the bill rate for near- and off-shore is roughly 1/3rd of the onshore bill rate.  As of 3Q 2022, offshore revenue represents ~30% of total company revenue.   Management envisions that the offshore business could become 50% of revenue and 70%-80% of billable employees within the next several years, with the tipping point to accelerating revenue growth as the company gets closer to a 50/50 revenue mix.  For reference, in Q3 (just reported)  offshore/nearshore organic revenue grew 32% y/y.  

The financial impact of this transition is straightforward.   Looking at a 5-year CAGR estimated through 2022, revenue grew 13% annualized, gross profit expanded 17% annualized (margin up > 500 bps), adj EBITDA grew 24% annualized, and earnings per share up 28% annualized.   Prospectively, management has intimated that it may reinvest the natural margin uplift to drive faster top-line growth thereby augmenting the historical growth algorithm. 

          

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Acquisition Strategy

Acquisitions are a central component of the company’s strategy to build its near- and offshore capability.  Typically management seeks to acquire ~$50m of revenue annually through a few small deals.  Historically acquisitions have added ~5 points to topline growth.  They are focused on “all things digital” which will not only enhance technological capability, but also can bolster ts competitive positioning, and diversify and diversifying client vertical exposure.  For example, acquisitions have enabled Perficient’s offshore billable employee mix to grow from 15% in 2014 to 56% in the latest quarter.  From a relative perspective to other companies in the industry, ~56% billable employee mix compares to peers such as Accenture and Cognizant which are in the 70%-80% range.   Continuing to build out global capability will enable greater flexibility and competitiveness.  

Source: Morgan Stanley

Timing

Pefficient is not immune from the macroeconomic backdrop.   In Q3 management indicated that it is seeing elongated sales cycles.   In addition, the company is exiting its relationship with a significant healthcare client (Kaiser) that is weighing on revenue growth, and in 2Q management noted a couple of idiosyncratic project cancellations.  For the fourth quarter management is calling for ~8% organic growth and ~10% overall revenue growth, including $8 million from recent acquisitions.

Ultimately, the company is better positioned to weather a downturn due to its development of a global delivery model which allows clients to reduce spend without cancelling projects, and shift in client mix towards larger accounts with more resilient IT budgets.  

 

Balance Sheet

The company ended the quarter with $375 million of net debt, this compares against estimated 2022 EBITDA of ~$200 million, or <2x net leverage.  

 

Management

CEO Jeff Davis has been in his current role since 2003 after joining Perficient as the COO in 2001.  Prior to Perficient, Jeff was the COO at Vertecon, a company Perficient acquired in 2001.  Before Vertecon, Jeff was a senior manager in Arthur Andersen’s Business Consulting Practice.  During his tenure leading Perficient, the company has seen its sales and share price more than 10x.  

 

Valuation & Peer Comparison

Current valuation is below the long-term average ~14x forward earnings.  This compares to an average versus the company’s own history of ~17x.    A low-teens multiple is typically associated with low/no growth companies in the IT services industry.  As such, the valuation is at odds with the favorable growth trajectory of the business.   When macroeconomic concerns and impacts eventually abate, this leaves room for potential multiple expansion.  Put another way, the decline in the multiple also substantially reduces multiple-compression risk for investors today.  

 

Large-cap IT services firms and digital pure-play IT services firms represent the best comparisons.  These companies include Accenture, Cognizant Technology Solutions, Infosys, EPAM, Edava, and Globant.  Despite generating earnings growth on par  with some of the fastest growing companies in the industry, Perficient trades at a substantial valuation discount as shown below.  Thus, if Perficient is successful executing its strategy and growing its business at attractive rates going forward, comparable company analysis would suggest investors can potentially benefit from substantial multiple expansion in addition to growth in the business.

 

Risks

  • Shorter contract length

  • Execution risk transitioning to lower-cost jurisdictions

  • Macroeconomic conditions affecting IT spending

 

I do not hold a position with the issuer such as employment, directorship, or consultancy.
I and/or others I advise hold a material investment in the issuer's securities.

Catalyst

Catalysts

  • Racceleration in organic sales & earnings growth

  • Accretive M&A

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