- Kerrisdale Capital - https://www.kerrisdalecap.com -

Luxoft (LXFT)

Kerrisdale Capital will host a conference call today at 11:00am EDT to discuss the Luxoft report.

To participate in the conference call, dial 888-567-1602 (US and Canada) or 862-255-5346 (international) and reference the Kerrisdale Capital call.

A replay will be available following the call at kerr.co/lxft-oct4 [1].

 

We were impressed with the quality of Luxoft’s people. More than 70% of Luxoft employees are senior specialists with over 7 years of experience, and over 80% are educated to Master’s or Ph.D. level. At Luxoft we’ve found teams of experts ready to grill you with tough questions. And that’s what you need on complex projects.

Daniel Marovitz, Former COO at DB’s global banking unit [2]

We are long shares of Luxoft as we believe the company is poised to double revenue over the next five years, and then do so again over the subsequent five. Luxoft’s stock has declined in 2016 as investors have become concerned with slowing growth. The recent move by the U.K. to leave the European Union exacerbated the weakness as the European banks (including Deutsche Bank, Luxoft’s largest customer) are being pushed to multi-year lows. However, Luxoft remains a premium vendor whose services are mission critical for clients. The recent renewal of a five-year Master Services Agreement (MSA) with Deutsche Bank illustrates customers’ reliance on Luxoft despite a challenging market environment.

With a revenue base of over $680 million, Luxoft resembles Cognizant (CTSH) 10 years ago, highlighted by a comparable growth trajectory. Cognizant’s revenue exhibited a remarkable 37% CAGR over a 15-year period, developing from a modest $89 million in 1999 to a $10 billion offshore powerhouse. We think LXFT can grow at a similarly high rate over the next 10 years. Our view is underpinned by management’s recent guidance of 20% compounded revenue growth, $1.5 billion in revenue by FY 2020, and a resulting market capitalization of $3 billion within five years. In fact, we think that forecast is conservative. A more likely scenario: LXFT multiplies its revenue base by 4-5x supported by its position as a best-in-class provider of high-end software developers serving a massive total addressable market. Our DCF analysis suggests shares are worth ~$108 today (105% upside) and likely more in time.

Luxoft’s differentiated focus on high-end software development is executed via engagement of leading programming talent in the science-centric Central and Eastern European (CEE) region. Unlike the large Indian vendors deriving value primarily from labor arbitrage, LXFT’s value proposition is predicated on an exceptionally skilled employee base to deliver sophisticated domain expertise. LXFT employs nearly 9,000 offshore programmers in the CEE geography, a region deeply rooted in science and technology; these emerging economies produce nearly one million engineering graduates annually. The company has already achieved success with this strategy, growing revenue at a 27% CAGR over the last five years while building out proficiency in sectors such as financial services and automotive. Furthermore, Luxoft commands a premium bill rate and generates the highest revenue per employee within the offshore industry. In an industry that competes aggressively for talent, LXFT boasts the lowest attrition rate among its peers.

The offshore IT services industry is well-positioned to grow, fueled by a significant enduring cost differential between U.S. and non-U.S. IT employees. The current climate of hyper-paced digital advancements within every industry, coupled with a shortage of talent in the U.S., will result in continued outsourcing of labor to countries with a cheaper and more abundant workforce. While the total offshore IT industry is expected to grow at 9% through 2019, the application outsourcing sub-segment in which Luxoft operates is projected to grow at 14%. Luxoft’s ~9,000 IT employees represent a mere fraction of the hundreds of thousands employed by the Indian vendors, and its LTM revenue of $681 million is a tiny portion of a thriving $60 billion industry. If LXFT and its CEE peers attain a quarter of the success realized by their Indian counterparts in the late 90s and early 2000s, LXFT will not remain a $1.7bn, or even $10bn, company for much longer.

I. Investment Highlights

LXFT Commands High Bill Rate

 6-lxft-commands-high-bill-rate

Application Outsourcing Projected to Outgrow Overall IT Spending

7-application-outsourcing-projected-to-outgrow-overall-it-spending

Source: IDC worldwide offshore IT services forecast.

Headcount vs. Indian Players

8-lxft-headcount-vs-indian-players

Source: Company filings and press releases.

 

Countries with Most Engineering Graduates

countries-with-most-engineering-graduates

Source: World Economic Forum 2015 / UNESCO Institute for Statistics.

Note: Excludes China and India.

Discounted Cash Flow Analysis

lxft-discounted-cash-flow-analysis

Source: Company filings and Kerrisdale analysis.

Attrition Relative to Industry

11-attrition-relative-to-industry-lxft

Source: Company filings and press releases.

Revenue from DB and UBS

 revenue-from-db-and-ubs

Source: Company filings.

 Read our full report here [3].