Stewart's Shop of IT Consulting

Aug.29.07 | About: Perficient, Inc. (PRFT)

On Friday, August 22, while discussing Perficient’s business strategy and growth plans with Mr. Jack McDonald (Chairman and CEO of Perficient), I learned of a $20bn niche IT consulting market that deals with project consulting for small initiatives at large IT shops.

The following is an example that explains this practice. Let us assume there is an insurance company that has an IT budget of $100mn per year. The company usually has two or three big IT outsourcing companies that are targeting big, fixed price service level deals that will be delivered from offshore. This usually involves application maintenance, BPO and long term software development activities.

But the insurance company might have immediate short term IT development requirements, as they are short term in nature so they usually don’t qualify for offshore development. As these projects don’t fall onto the radar of big IT outsourcing companies like Infosys or Wipro, the insurance company has to look for local vendors to cater to these short term projects. Usually these local vendors are mom and pop companies that have good rapport in the local IT market.

Until a few years back, Perficient (NASDAQ: PRFT) was one such small local company. But CEO Jack McDonald’s vision and smart acquisition strategy has helped the company substantially scale up its operations from an 8 person startup in 1999 to over 1,200 person fast growing company in 2007. With more than 80% of its revenue coming from repeat business ,Perficient has established a strong foothold in this niche project consulting market which requires fast turnaround of onshore resources.

BUSINESS OF STEWART'S SHOP: With the advent of large retail giants like Walmart, people had expected that the neighborhood stores like Stewart's shop will be out of business. In fact they have grown steadily and have retained their niche market of loyal customers who are ready to pay a premium price for convenience that these stores offer. It is evident from the fact that most people pay $3.00 a gallon for milk in neighbor hood stores when they very well know that they can buy it for $2.75 in Walmart. The reason is that the 25c savings is not worth the effort of driving a few miles. So the neighborhood stores like Stewart’s that are still in business are solely surviving on the convenience they provide to their customers.

The same can be applied to the business of IT consulting. The Walmarts of IT consulting like Accenture and Infosys are going to be the talk of IT business. But the Stewart’s shop of IT consulting like Perficent will also enjoy customer loyalty because of the convenience they offer to their customers.

ABILITY TO HIKE THE SALE PRICE: One of the first questions that comes to my mind while analyzing a stock for investment is : Can the company hike its sale price and still retain their customers? In case of Perficient the answer is positive. Their current average billing rate of $114/hr has increased considerably last few years.

AMPLE REQUIREMENT FOR USA BASED IT SERVICES : Since the technology melt down of 2001, the IT services market has steadily picked up. I will not quote any fancy report from Gartner to prove this fact. My most reliable yard stick is the number of open positions in the IT job portal In September 2004 it used to have on an average 54,000 open positions. As of today there are over 95,000 open positions. For the non techie guys - is a portal that advertises IT positions that are open in USA. The increase in its open positions indicates the steady increase in demand for IT services to be performed in USA. This is an indication of a growing market for Perficient's services.

WHAT ARE THE MAJOR CHALLENGES IN THIS MARKET: One of the biggest challenges is to respond to a client's requirements in a very short span of time. As explained above, Perficient's customers approach them when they need a fast solution for their business needs. In today's IT world, hiring skilled programmers can be like searching for a good date!!! In order to meet the demand of its customers the IT services companies would need a large reserve of resources. With smart use of subcontractors, Perficient has been able to respond quickly to its client’s requirements and the same time it has kept a high utilization rate of 83%.

Second challenge is growing inorganically by acquisitions. As this industry is fragmented, it is very difficult to acquire a company with a particular domain expertise and to integrate it with the parent company. When asked about the two key factors Perficient looks for while acquiring a company, Jack replied "Culture and domain expertise. In fact we would minutely analyze the culture of the company we are acquiring and make sure they will fit in our organization." With 8 acquisitions in 3 years and an attrition rate of just 17%, the company has done a phenomenal job in retaining the folks that have come in with acquisitions.

FUTURE OF PERFICIENT : Jack concluded our conversation by mentioning "We are targeting revenues to be around $500mn by 2010." Assuming an average billing rate of $125/hr by 2010. Perficient will need around 2,000 billable resources (assuming 2,000 hrs per year for each resource) to reach this figure. Considering the present strength of 1,200 the mark of 2,000 resources seems daunting, but Perficient's formidable record of successful acquisitions is going to boost its inorganic growth. The company is also vigorously hiring smart young professionals who have around 5 years IT consulting experience. Coupled with the experienced hires, around 10% to 15% of their new hires come straight out of college. This shows a culture of long term growth potential for employees. If their growth plans go as planned and the earnings increase to around $20mn by end of 2008, assuming a P/E of 50, the stock has a great chance of crossing the magic figure of $1bn in market cap by end of 2008.