EPAM is a company that offers software engineering and product development solutions in the IT services space, being one of the leaders in the industry. The company occupies a niche space in consulting and outsourcing fields, focusing on lifecycle software testing, product deployment and end-user customization, performance tuning, managed services, and cross-platform migration, among other tasks. EPAM’s main competitors are Accenture, IBM, Cognizant, and Infosys, though its core differentiating factor is the labor sourcing platform, since the vast majority of the company’s employees come from Eastern Europe, largely Belarus, Ukraine, and Russia. EPAM serves technology companies in financial service, travel and consumer, software and hi-tech, media and entertainment, as well as healthcare. It derives about 50% of revenue from the United States, 40% from Western Europe, and approximately 10% from CIS and the emerging markets.
Per our industry-wide analysis and EPAM’s strong fundamentals, as well as in light of the recent favorable guidance, we believe that EPAM shares merit ~22x PE multiple on 2020 earnings. We note that this multiple comes at a ~1.5-2x discount relative to other players in the IT Services space. When we apply it to our 2020 non-GAAP EPS estimate of $9.75 (down from our previous estimate of $9.77), we get the target price of $215.
Risks to Our Thesis:
Given that Epam Systems sources labor force from the relatively volatile region of Eastern Europe, such as Belarus, Ukraine, and Russia, we believe that political turmoil or destabilization could be harmful to the company’s operations. We saw how in 2014 EPAM shares plummeted 10-15% on the news of political upheaval in Ukraine. Further, continued sanctions levied on Russia could have a negative top-line impact on EPAM, albeit the company derives only 3-4% of total revenue from Russia.
2. Pricing Wars:
While EPAM strives to make the pricing structure attractive to its core clients and, henceforth, attract greater business, we see Luxoft, EPAM’s main competitor, potentially (and selectively) lowering prices as well. In turn, this could lead to a pricing war and result in lower revenues for both parties.
3. Concentrated Revenue:
With top 10 clients constituting about 45% of total revenue, we see any defection of a client or a reduction in the scope of the project as an inherent threat.
4. OPEX Pressures
The company faces incremental operating pressures, as it opens new markets not only to attract new clients but also to find new sources of labor. We believe that mismanagement of new opex investments may lead to higher-than-expected margins and thus threaten the company’s valuation.
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