IT engineering
June 2022
IT engineering, also known as next generation or digital transformation, focuses on the integration, implementation, operation and administration of computer systems, using computer technologies as the main tool in production processes.
The growing evolution of the fourth industrial revolution, or also known as industry 4.0, has meant that the demand for automated and digital technologies in the manufacturing industry has increased rapidly in recent decades.
Manufacturers are increasingly adopting the latest technologies to automate and digitize the process to improve product quality and productivity.
The growing demand for the latest and most advanced technologies such as big data analytics, artificial intelligence, internet of things, and cloud computing in various business enterprises is significantly driving the growth of the global digital transformation market.
These latest technologies help embed artificial intelligence into business activities and promote customer engagement while delivering operational efficiencies.
The intensive advancement of the Internet, the growing adoption of smartphones, and the development of technology integration and telecommunication infrastructure across the globe are some of the major indicators driving the growth of the digital transformation market across the globe.
Companies from different sectors are investing heavily to increase their digital presence. Therefore, the shift from traditional business to digital business is significantly increasing the growth of the global digital transformation market.
The sector is currently growing at rates of 10% per year and a growth of 15%-20% is expected up to 2028 globally, a growth rate of almost 4 or 5 times higher than world GDP.
It´s a sector that grows at a high and constant rate, where companies are usually very profitable due to their asset light structure, most companies generate large profits with low reinvestment.
The following study by Precedence Research forecasts global growth of 15% per year until 2030, reaching market figures of more than $1.6 trillion
In optimistic studies, a market of 1.100 billion is estimated by 2025, a growth of 19% CAGR.
Types of IT companies
IT Services
Within the IT sector, IT service companies are the most boring
They are the companies that provide the least value to the customer
They take software and install it for the client, they adapt it according to their needs
They usually use local Engineers
The workforce is in the country where it operates
On average they grow by 1.5% per year and the strongest grow by an average of 4%
In this sector, organic growth is one of the most important variables to consider.
Average EBITDA margin of 16.6%
Sector average valuation 10X EV/EBITDA
Offshore IT Services
They are similar to those of IT services, but it provides something more of added value.
Use the offshore model, they subcontract these jobs in regions such as India, Latin America or Eastern Europe, where the salary of an engineer who does the same as an engineer in the US or Europe can be 70%-80% less
It is a very competitive market and there is little growth, because what companies need today is custom software and more specialized solutions (where maintenance and updates are added later).
They have two segments, the old one that is in decline with growth of 4% and the new one that grows at 15%, an average of 8%, so it is still a good business.
Next Generation IT
Within IT companies, engineering or Next Generation companies are the ones with the highest growth.
They are oriented to create software and solutions tailored to the client, doing something much more specific.
It draws on both types, with a local engineer model and an offshore model, but generally tends to use more offshore engineers.
It has high EBITDA margins of 19%
They grow an average of 33%
They trade on average 43x EV/EBITDA (currently at 30x)
Companies like Epam, Globant, Endava, Nagarro, Spyrosoft, accenture
Advantages of the sector
Switching costs: The client is closely linked, because the company develops an app, the company knows how it works and will make the updates, for convenience because if another company comes it would have to learn from scratch, and companies simply don´t change.
High recurrence of income: In this sector, little money is earned for the initial project, and then all the money is earned with maintenance, updates. Like what they do, it helps customers reduce costs, when there is a crisis, companies are more aware
Low cyclicality: There should be no surprises in the quarterly reports. The key is that the company's capabilities are in demand and that the company has many complementary lines of business (one stop shop) that the company does everything, thus keeping the customer more tied. For this reason they make acquisitions to complement business lines
High ROIC: You don't have to invest much. It is the typical technology business where ROICs are high, 20% minimum, 25%-30% upwards
Regarding inflation: They are good companies because, as Warrent Buffett says. They have little need for reinvestment in fixed assets (these rise with inflation). They can raise prices (pricing power) because there is excess demand
Fragmented market: Many small companies that at some point are going to consolidate. Epam, which is one of the largest in the sector, invoices 5 billion, in a market of 400 billion, a 1% market share
Dispersion of valuation : There are some companies that the market knows and are at demanding multiples and others that are in a range similar to the market average
High FCF when growing: After you have invested, the ROIC is very high. Of the 100% of the FCFO that it generates, they generally invest 10%-20% and can grow to 20% organically. A company with a low ROIC of 15% has to invest 200% of the FCFO to grow at 30% and that money comes from issuing shares or debt.
Some companies in the sector
Key points
The cloud computing segment is expected to grow at a rate of 27.8% CAGR over the next few years (2030).
The Implementation and Integration Services segment is growing at a CAGR of 26.6% during the forecast period.
The hosted segment is poised to grow at a CAGR of 30.5% during the forecast period.
The small and medium business segment is expected to grow at a CAGR of 28.4% over the next few years.
The retail segment is growing at a CAGR of 26.9% during the forecast period.
North America gained a market share of about 43.5% and dominated the global digital transformation market in 2022.
The Asia Pacific market is expected to achieve a CAGR of 29.5% between 2023 and 2032.
The increased use of online payment systems in retail sectors has significant contributions in the growth of the digital transformation market.
Increasing government initiatives to promote the adoption of digital and automation technologies in the healthcare, automotive, and pharmaceutical sectors are further driving the digital transformation market in many countries around the world.