Thoughtworks Stock: Acquisition as Growth Challenges Loom (TWKS)

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A quick overview of Thoughtworks

Works of Thought (NASDAQ: TWKS) went public in September 2021, raising approximately $774 million in gross proceeds from an IPO at a price of $21.00 per share.

The company offers a wide range of IT consulting services to customers around the world.

Given Thoughtworks’ apparent high valuation and growing growth challenges ahead, I’m holding TWKS in the near term.

Introducing ThinkWorks

Thoughtworks, based in Chicago, Illinois, was founded to develop a set of skills that enables companies to evolve and modernize their IT and digital infrastructures according to their business objectives.

Management is led by General Manager Guo Xiao, who has been with the company since 1999 and previously held numerous positions within the company and its subsidiaries.

The company’s main offerings include:

The company seeks advisory and integration relationships with enterprises through its direct sales and marketing efforts as well as through partner relationships.

Thoughtworks Market and Competition

According to a 2021 market research report by 360 Market Updates, the global digital transformation strategy consulting market was estimated at $58.2 billion in 2019 and is expected to reach $143 billion by 2025.

This represents a projected CAGR of 16.2% from 2020 to 2025.

The main drivers of this expected growth are a significant shift from legacy on-premises systems to cloud-based environments with complex architectures.

Additionally, the COVID-19 pandemic has likely advanced a significant demand for modernizing business systems, resulting in increased growth prospects for digital transformation consultants.

Major competitors or other industry participants include:

  • Global (GLOB)

  • EPAM (EPAM)

  • Slalom

  • Accenture (ACN)

  • Deloitte Digital

  • McKinsey

  • BCG

  • ideo

  • Cognizant Technology Solutions (CTSH)

  • Capgemini (OTCPK: CAPMF)

  • Internal company development efforts

Recent financial performance of Thoughtworks

  • The total turnover per quarter increased according to the following graph:

Total turnover over 5 quarters

Total turnover over 5 quarters (Looking for Alpha)

  • The gross margin per quarter has fluctuated over the last quarters:

Gross profit over 5 quarters

Gross profit over 5 quarters (Looking for Alpha)

  • Selling, G&A expenses as a percentage of total revenue by quarter varied, as shown in the chart below:

Sales over 5 quarters, G&A % of turnover

Sales over 5 quarters, G&A % of turnover (Looking for Alpha)

  • The operating result per quarter has been significantly negative over the last four quarters:

Operating result for the 5 quarters

Operating result for the 5 quarters (Looking for Alpha)

  • Earnings per share (diluted) remained negative as shown here:

5 quarters of earnings per share

5 quarters of earnings per share (Looking for Alpha)

(All data in the graphs above are in accordance with GAAP)

Over the past 12 months, TWKS stock price has fallen 55.5% compared to the US S&P 500 index down about 11.9%, as shown in the chart below :

52 week stock prices

52 week stock prices (Looking for Alpha)

Assessment and other metrics for Thoughtworks

Below is a table of relevant capitalization and valuation figures for the company:

Measure [TTM]

Rising

Enterprise Value / Sales

3.61

Revenue growth rate

36.0%

Net profit margin

-12.3%

% EBITDA GAAP

-6.7%

Market capitalization

$4,150,000,000

Enterprise value

$4,420,000,000

Operating cash flow

$79,490,000

Earnings per share (fully diluted)

-$0.52

(Source – Alpha Research)

Compared to the IT consulting and other services industry’s EV/Average Revenue multiple of 1.76x, the company is currently valued by the market at a multiple of 3.61x, a significant premium.

While the company recorded revenue growth of 36% over the last twelve months, the IT consulting and other services index averaged 27.04%. Thus, the company is valued by the market at around twice the industry average despite slightly higher revenue growth.

Commentary on reflective work

In its latest earnings call (Source – Seeking Alpha), covering Q2 2022 results, management highlighted an important differentiator in that the company is diversified across various industries and geographies.

The company provides consulting services for digital transformation, data and AI, cloud, customer experience, platforms, products and design.

In particular, management supplemented its organic growth efforts with targeted acquisitions. The company announced its second M&A deal in 2022 for a strategic design consulting firm in Brazil with 50 employees, giving the company an increased presence in Latin America.

The company also recently became an AWS Premier Services Partner, which management says is the highest level of partnership and “less than 3% of AWS Partners achieve this status.”

As for its financial results, total revenue increased 27.5% year over year, or 33.5% in constant currencies.

Adjusted EBITDA increased by 14.2% with a margin of 17.6% above previous guidance, although below the 2021 figure.

Adjusted gross margin fell to 40.6% from 43.5% in the second quarter of 2021, while adjusted general and administrative expenses were flat year-over-year.

EPS losses continued to be impacted by employee stock compensation, which dilutes shareholders in the process.

For the balance sheet, the company ended the quarter with cash of $275 million, up $59 million year-over-year. Debt fell by $100 million to $406 million at the end of July.

Looking forward, for the full year 2022, management expects revenue to grow at constant currency by approximately 30% at the midpoint.

Adjusted EBITDA margin is expected to be around 19.5% at mid-term, similar to previous May 2022 guidance.

As for valuation, the market values ​​TWKS at quite a high valuation compared to the overall IT consulting market.

The main risks to the company’s outlook are a combination of slowing macroeconomic conditions, reduced funding available to private technology companies and currency impacts on its results.

While management may choose the coming period to be more active in acquiring consulting firm targets that will serve to grow revenue inorganically, this strategy may mask a picture of more challenging organic revenue growth.

Given the apparent high valuation of Thoughtworks and the growth challenges ahead, I’m on hold for TWKS in the near term.

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