Endava Poised for Strong Recovery in IT Services Industry.

Endava, a founder-led IT services company, is expected to recover from its current valuation, which reflects cyclical macro woes. The company has attributes of a high-quality business with 80% upside potential. Its performance is not necessarily tied to the cyclical macro environment, making it a promising investment opportunity.

Endava (NYSE:DAVA), a founder-led IT services company, is poised to recover from its current valuation, which reflects cyclical macroeconomic challenges. The company boasts attributes of a high-quality business with significant upside potential, making it an attractive investment opportunity.

Endava specializes in complex digital transformation projects, differentiating itself through a distributed, agile delivery model. Its expertise lies in modernizing legacy core systems, a critical prerequisite for AI implementation. The company's focus on high-value work and strategic consulting sets it apart from traditional outsourced services providers, which often compete on cost and commodity tasks [1].

The IT services industry is experiencing a shift from commoditized tasks to high-end strategic consulting. Endava fits into the category of "engineering black ops," companies that compete on engineering excellence and speed. However, the company has faced headwinds due to a fragile macro environment, causing delays in large contracts and elongated sales cycles. This has led to a slowdown in revenue growth and a derating of valuation multiples.

Endava's strategic partnerships with OpenAI and Google, coupled with internal AI initiatives, position the company as a key enabler of AI in enterprises. The company's management team, led by CEO John Cotterell, maintains strong alignment with shareholders, fostering a healthy culture and aggressive buyback programs. This alignment is crucial for long-term growth and sustainability.

The company's business model, based on time and materials (T&M) contracts, is being challenged by the advent of Generative AI (GenAI). However, Endava's focus on complex, high-value work, such as data mapping and AI-ready data foundations, positions it to benefit from AI adoption. The industry's total addressable market (TAM) for IT services is roughly $1.5 trillion, growing at high single digits. If GenAI doubles coding efficiency, approximately $600-700 billion is at risk from traditional T&M structures. Endava's expertise in AI implementation is likely to contribute to significant demand [1].

Endava is actively positioning itself as a leader in this high-value niche. The company's founder-led nature allows it to act quickly, differentiating it from larger, bureaucratic competitors. Endava has created a new department, Dava.X, focused on accelerating technology adoption, and an innovation lab fostering AI innovation through global competitions. The company has forged alliances with industry leaders in GenAI, securing its position as an enterprise-grade trusted partner.

Financial implications suggest that Endava's management team has proven effective in driving gross margin expansion. Gross margins hover in the mid-thirties under normal macro conditions and contracted to mid-20s in 2024 due to macro pressures. As macro conditions normalize and AI proliferation continues, gross margins are expected to expand back towards mid-30s. The company's debt is manageable, with a 1.7x Net Debt/EBITDA ratio, posing no significant insolvency risks [1].

Endava's recovery trajectory is expected to be significant, with an 8% Revenue CAGR through 2028 and margin recovery as pricing dynamics return to healthy levels. The company's expertise in AI implementation is already a key priority for CIOs, positioning it to capture above-market growth. The market growth underpinning these assumptions is roughly 4% CAGR, aligning with industry projections.

Conclusion

Endava's recovery potential is substantial, with a total return of 80% and an IRR of 19% through 2028, assuming a 9x P/EBIT multiple. The company's strategic focus on high-value AI implementation and strong management team make it a promising investment opportunity amidst cyclical downturns.

References

[1] https://seekingalpha.com/article/4812637-endava-setting-up-for-a-recovery