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The following segment was excerpted from this fund letter.
Endava plc (NYSE:DAVA)
Our laggard Endava has detracted ~ 350 bps from performance this quarter. Endava was down 40% after it reported earnings in February. This was a 3% position before this decline, but we have since added to the stock to make it one of the top 5 positions (by cost) in the White Falcon portfolio. Endava is a founder-led IT service provider headquartered in London, UK. It competes with the likes of Accenture (ACN) and provides IT services to clients in the financial services, travel, retail, software, healthcare among other industries. We believe scaled IT service providers are good businesses as they are essentially a ‘royalty’ on IT spend. They are an important link between technology and corporations who increasingly need technology to transform their business. We see a favorable backdrop for businesses like Endava with rising investments in technology, growing trends in outsourcing, and the emergence of new technologies such as Artificial Intelligence (‘AI’). Importantly, we believe that Endava has the culture, scale and competencies required to succeed.
So what happened? Endava guided for negative growth in its business for the current fiscal year (ending June 2024). On the other hand, management had made hiring decisions expecting a growth in revenues, leading to a mis-match in the cost structure. Due to this, operating margins collapsed and Endava’s earnings are likely to decline ~30% in FY 2024 compared to FY 2023.
“Uncertainty is the friend of buyer of long term value”
-Warren Buffett
Client projects are being delayed due to three reasons, (1) AI is new and clients require time to discern the optimal use-case scenarios, leading to a cautious “wait and see” approach; (2) IT services ‘over-earned’ during Covid and had a stellar performance in 2022. Some of this is now normalizing as clients ‘digest’ previous implementations; and (3) Endava is over-exposed to the financial sector, specifically payments, a sector that is seeing a pronounced slowdown in demand.
Clients may postpone these projects temporarily, but ultimately, they will need to invest in order to maintain competitiveness. In essence, Endava (and EPAM) is currently going through a phase of cyclical weakness which, we believe, will subside in the near future leading again to strong topline growth. Importantly, Endava has a robust balance sheet and a capable management team, instilling confidence in their ability to effectively navigate these challenging circumstances. At 11x LTM EV/EBITDA and potentially 8x NTM EV/EBITDA, we believe the risk-reward is favorable for an increased allocation to Endava.
As we have mentioned before, our philosophy on portfolio construction is that we want to be concentrated enough to matter but diversified enough to survive. Even with dramatic drops in stock prices of Endava , our performance overall was not unduly affected. We manage risk at the business level and at the portfolio level by utilizing appropriate position sizing. In fact, these drops help us add capital to attractive opportunities. Even as the general markets are at an all-time high, we remain optimistic on the White Falcon portfolio due to business such as Endava in the portfolio, which we believe we have underwritten at very attractive IRRs.
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Disclaimer Past performance is not necessarily indicative of future results. All investments involve risk, including the loss of principal. It should not be assumed that any of the transactions or investments discussed herein were or will prove to be profitable, or that the investment recommendations or decisions we make in the future will be profitable or will equal the investment performance of the investments discussed herein. Specific companies or investments shown in this presentation are meant to demonstrate White Falcon’s active investment style White Falcon may change its views about or its investment positions in any of the securities mentioned at any time, for any reason or no reason. White Falcon disclaims any obligation to notify the market of any such changes. The information and opinions expressed in this presentation is based on publicly available information about the securities. The letter and thesis includes forward-looking statements, estimates, projections, and opinions, as well as more general conclusions. Such statements, estimates, projections, opinions, and conclusions may prove to be substantially inaccurate and are inherently subject to significant risks and uncertainties beyond White Falcon’s control. Although White Falcon believes the data and numbers are substantially accurate in all material respects, White Falcon makes no representation or warranty, express or implied, as to the accuracy or completeness of any written or oral communication. Readers and others should conduct their own independent investigation and analysis of the thesis of any and all companies mentioned in this document. The letter is not investment advice or a recommendation or solicitation to buy or sell any securities. White Falcon undertakes no obligation to correct, update, or revise the Presentation or to otherwise provide any additional materials. White Falcon also undertakes no commitment to take or refrain from taking any action with respect any of the companies mentioned in this letter. |
Editor’s Note: The summary bullets for this article were chosen by Seeking Alpha editors.
