Perficient: An Opportunity For Long-Term Technology Industry Bulls

Investment Thesis:

Perficient Inc. (NASDAQ:PRFT) has been performing very well post Covid-19. The company has been capitalizing on the digital transformation opportunity, which will be accelerated at a CAGR of 16.5% with an expected investment of $6.3 trillion (about $19,000 per person in the US). The numbers look consistent for revenue, and EPS growth has been 21% over the last five years. The company has a long track record of success in providing IT consulting services combined with its focus on emerging technologies like cloud computing and artificial intelligence (AI). PRFT’s performance has remained solid despite economic headwinds over the past few years, making it one I plan to watch and evaluate going forward.

What do they do?

Perficient Inc is a digital transformation consulting firm that provides a range of services such as strategy, design, and technology solutions and is headquartered in St. Louis, Missouri, USA, with 7500 employees. The company also offers specialized services, including cloud computing, analytics & data management, mobile application development, eCommerce platforms & integration solutions. They creatively approach their work by embracing recent technologies, techniques, and design principles to deliver innovative and practical solutions to their clients.

Recent Corporate Performance:

Perficient’s business strategy is focused on delivering digital transformation solutions to clients in specific industries and service areas. The company’s industry focus, service offerings, acquisitions, partnerships, and employee engagement are vital components of its strategy.

The company performed exceptionally well in the third quarter of 2022, with an 18% quarterly year-on-year revenue growth and a 33% increase in EPS. In addition, the company expanded with two significant acquisitions in September & October, further strengthening its growth. As a result, growing revenues and improved EBIT margins present sustainable profit growth.

The company has increased its debt significantly over the past few years, with long-term debt rising in September 2022 to $394 million from $187 million in just one year.

Strengths:

Perficient Inc.’s strengths include an experienced leadership team successfully navigating through challenging economic times, including a global pandemic and recent tech layoffs. In addition, it has a diversified business model in a range of capabilities; a strong presence across different industries & geographies (presence in 11 countries with 34 offices) that helped minimize economic cycles’ impact on its performance.

Perficient has a robust portfolio of emerging technology offerings, including software development, analytics, data science, artificial intelligence (AI), machine learning (ML), and more. This positions the company to capture growth opportunities in this rapidly evolving digital landscape.

The company tried to strengthen its global delivery capabilities and capacity with two acquisitions in 2022. Most recent one was in October, the acquisition of Ameex Technologies Corporation, a digital experience consultancy based in Schaumburg, Illinois, with offshore operations in Chennai, India.

And, to focus on its nearshore development expertise, it acquired Inflection Point Systems, Inc. in September, a software consulting, and product development firm based in Columbia, Maryl, for $60.2 million, comprising of $44.6 million in cash, $2.6 million in common stock, and $13 million in contingent payments. Despite having $39 million in cash as of June 2022, the company’s ending cash balance for September 2022 was $21 million. However, the company’s cash from operations grew by a staggering 353% over the last quarter, indicating that the acquisition will not put any significant financial burden on the company. It remains financially strong to support such acquisitions in the future.

Weakness:

Perficient’s higher return on equity of 22% compared to its peers is due to its significant reliance on debt, with a total debt of around $394 million as of September 2022. This is reflected in the company’s higher debt-to-equity ratio of 1.02, compared to its peers’ ratio of 0.22, indicating that Perficient has less equity and more debt for its operations.

The company relies heavily on its senior salespeople, with 18 out of 175 sellers generating approximately 60% of its revenue. This business model is not sustainable, as the company’s revenue could be significantly impacted if these top performers were to underperform or leave the company.

Another concern is the company’s project-based business model, in which the revenue is recognized over time. Even the length of its projects affects fluctuations in revenue and profitability. The intense competition faced by the digital transformation consulting industry puts pressure on the company’s margins. In addition, Perficient competes with large consulting firms such as Accenture (ACN) and Deloitte and smaller specialized firms.

Perficient has grown significantly through acquisitions. While acquisitions can provide a growth path, they also carry integration risks. Failure to integrate acquisitions successfully could lead to operational inefficiencies, negatively impacting the company’s financial performance. Additionally, acquisitions can be costly, and the company’s financial performance could suffer if it takes on too much debt to finance its acquisitions.

Looking forward

I have valued the company based on discounted cash flow (DCF) and comparable company multiples valuations. Based on the above methods, the average intrinsic stock price is around $50 compared to the $77 the stock is currently trading at.

Looking at the P/E multiples, the firm is trading at 34x compared to the sector median of 21x. So according to this method, the firm is highly overvalued.

When I look at the EV/EBITDA multiples, the firm is trading at an EV/EBITDA multiple of 18x compared to the sector median of 12x. The stock price is overvalued based on comparable company EV/EBITDA multiples.

My assumptions for the DCF valuation are

• 36-month Beta: 1.678

• Cost of equity: 13.40%

• Cost of debt: 4.3%

• Weighted Average Cost of Capital (WACC): 8.68%

Conclusion:

Notwithstanding the weaknesses, Perficient Inc has solid fundamentals and is producing profits. However, the stock is excessively overpriced based on all three valuation approaches, and its intrinsic valuation price stands at approximately $50. As a result, I am currently putting a Hold rating on the stock. In addition, my analysis of this stock’s intrinsic value and fundamentals suggests that its growth potential may have reached a plateau for the time being. I will reassess this recommendation after its next earnings announcement at the end of February.