Navigating The Grid

By: subSPAC

EXECUTIVE SUMMARY

• As the current digital landscape continues to evolve, companies are racing to adapt to the new normal.
• Grid Dynamics has successfully capitalized on this demand, delivering services across Cloud, Data, AI, and Digital Experiences.
• As a result, the company has enjoyed impressive growth and significantly expanded its clientele over the last few years.

DETAIL

As the current digital landscape continues to evolve, companies are racing to adapt to the new normal. Grid Dynamics has successfully capitalized on this demand, delivering services across Cloud, Data, AI, and Digital Experiences. As a result, the company has enjoyed impressive growth and significantly expanded its clientele over the last few years. But as Grid Dynamics encounters emerging headwinds and a possible market slowdown, can it successfully adapt to these challenges and continue to thrive?

Powering Through the Digital Frontier 

The digital transformation market is set for substantial growth, with projections indicating it will more than double over the next decade, from $588 billion in 2010 to over $3 trillion by 2020. As enterprises continue to shift their focus to online and mobile platforms, this burgeoning market offers a lucrative opportunity for investors to capitalize on the industry’s rapid expansion. Enter Grid Dynamics, a provider of next-gen IT services founded in 2006 in the Bay Area.

The company has built a solid reputation by solving clients’ most complex algorithmic challenges through distributed computing. With assistance from Silicon Valley technology leaders, Grid Dynamics refined and expanded its service portfolio, becoming widely known for its expertise in emerging cloud technology, and big data. The company’s growth was further fueled by the increasing demand for online and mobile commerce solutions, which helped secure its position as the digital partner of choice for top US retailers. 

Fast forward to today, and Grid Dynamics now boasts a presence in 13 countries. The company’s clientele includes heavyweights like Apple, Google, LVMH, Tesla, Visa, Paypal, Lowe’s, and Verizon. Grid’s European presence has also expanded through the recent acquisition of Netherlands-based Daxx in 2020 and UK-based Tacit Knowledge in 2021. One of Grid Dynamics’ primary strategies for growth is leveraging the highly fragmented market to identify and acquire high-quality targets at accretive valuations.

Their globally distributed delivery model equips them with the expertise necessary to successfully execute transformational acquisitions at the right time. Recent examples of this strategy in action include the acquisitions of Mutualmobile, a design and digital platform engineering services company based in the US and India, and NextSphere, a full-service custom application development company based in Tampa, FL, and India. These acquisitions aim to expand the company’s reach across applications in AR/VR, Edge Cloud, Healthcare, Fintech, and CPG, solidifying Grid Dynamics as a top player in the digital transformation space.

Proactive Adaptation

Grid Dynamics is navigating a complex market environment characterized by several headwinds. A cautious spending atmosphere has emerged as businesses grow increasingly careful about their investments across various industry verticals. This shift has led to volatility across its client base, with clients taking a closer look at the health of their businesses and making short-term investment decisions. As customers reevaluate their IT partners and streamline their relationships, the competition to remain a preferred provider intensifies.

Additionally, the trend towards offshoring development to lower-cost locations has increased pressure on companies like Grid Dynamics to maintain their competitive edge in the global market. Compounding these challenges is the easing labor market, which has led to a rise in in-house development, potentially reducing the demand for Grid Dynamics’ services. Furthermore, the increasing use of AI to replace certain functions poses a challenge to traditional IT service providers, as businesses are increasingly seeking AI-driven solutions to optimize their operations.

Despite the headwinds, Grid Dynamics is proactively adapting and taking measures to mitigate their impact. By focusing on recession-resistant industries that continue to invest even in the face of cautious spending, the company is looking to secure stable revenue streams. Moreover, Grid Dynamics is expanding its presence in cost-effective locations like India, leveraging its new office in Hyderabad and the acquisition of Next Sphere Technologies to access a large talent pool of engineers in Chennai.

In addition to geographical expansion, Grid Dynamics is investing in building its in-house AI expertise to stay ahead of the curve and develop AI solutions tailored to clients’ needs. By developing strong AI competency, Grid Dynamics will not only addresses the challenge posed by AI replacing certain functions but will also be prepared for future growth to capture new opportunities. 

Financials and Valuation 

As the pandemic fueled a rise in digital transformation, Grid Dynamics experienced rapid revenue growth and increased profitability. The four key verticals where the company focuses its efforts – Cloud, Data, AI, and Digital Experiences – saw a surge in demand, pushing revenue growth to unprecedented rates. From growing at around 30% pre-pandemic, revenues accelerated to 90% and 47% in 2021 and 2022, respectively.

Grid Dynamics’ success in scaling its existing relationships is evident by the growth of $1 million+ customers, growing more than fourfold from 11 in 2018 to 48 in 2022. Additionally, customer concentration has fallen from 90% of revenues coming from the top 10 customers in 2018 to 60% in 2022. The company’s revenue distribution has become increasingly diversified, with revenues now spread evenly between Technology, Media, and Telecom (TMT), Retail, and other sectors like Finance and CPG.

Despite this long-term growth trajectory being intact, Grid Dynamics’ stock experienced a 20% drop in a single day last week, erasing nearly $200 million in market cap, following weaker-than-expected growth in the first quarter. The company reported Q1 revenues of $80.1 million, a 12.1% YoY increase but a 0.4% sequential decrease, primarily driven by a slowdown in the Technology, Media, and Telecom sectors.

For the second quarter, the company anticipates revenues of around $76 million, while the full-year revenue outlook is expected to be around $370 million (both are below consensus forecasts). With a current market cap of $670 million, Grid Dynamics trades at a forward Price/Sales ratio of around 1.8x, which appears reasonable compared to its peers. However, it is important to consider the potential slowdown across enterprise markets due to the recession and easing of the labor market domestically in the US, where 82% of Grid Dynamics’ revenue is located, as factors that may influence the company’s valuation moving forward.

Bottom Line 

Grid Dynamics has showcased remarkable growth in the rapidly expanding digital transformation market, thanks to the rising demand for its expertise in Cloud, Data, AI, and Digital Experiences. The company has successfully diversified its client base and strategically expanded its global presence, positioning itself as a key player in the industry.

Short-term headwinds persist, but Grid Dynamics is looking to mitigate the challenges by focusing on recession-resistant industries and expanding its presence in cost-effective locations. While the company’s valuation seems reasonable when compared to industry peers, investors must consider potential market slowdowns and the effects of a shifting labor market on Grid Dynamics’ future growth prospects. 

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Originally Posted May 9, 2023 – Navigating The Grid