Cognizant Technology Solutions Corp.’s shares rose 4% on the Nasdaq after it called a truce with activist investor Elliott Management Corp. The company will start paying dividends as well as increase the quantum of buy-backs substantially. As a result, it will return as much as 75% of free cash flow to investors from 2019, up from around 30% currently. Besides, it plans to improve margins to around 22% by 2019, which is a big shift for a company that has told investors for nearly two decades that it will reinvest margins in excess of 20% for growth.
In a late November letter to the Cognizant board, Elliott had dismissed this as an “antiquated, growth-at-all-costs” business model. It had asked the company to focus on total shareholder returns instead.
With Cognizant agreeing to most of Elliott’s demands— including enhancing its board of directors to benefit from new perspectives—it’s clear growth won’t remain an all-out priority. In fact, in a call with analysts, chief executive officer Francisco D’Souza said, “We will make careful choices among business opportunities to avoid less profitable areas to balance growth and margin. While this strategy might lower our revenue growth in this part of the business (traditional services), we believe it will be offset by strong digital revenue growth, resulting in robust, higher-quality growth for the company overall.”
Not that this is a bad move; although it needs to be seen how the shift in business strategy plays out. If some of the fears around visa constraints for immigrant workers materialize, improving margins may prove to be an uphill task as well. Part of the company’s new strategy is to invest in digital services, with a view to driving sustainable and profitable growth.
In 2017, Cognizant expects growth of between 8% and 10%, which is more or less in line with the 8.6% growth reported in 2016. The company is clearly past its prime, as far as growth goes (see chart).
For Cognizant’s India-based competitors, the new strategy may well result in some additional business. Of course, this is hardly anything to get excited about, considering that it is likely to be low-margin business.
What Indian IT firms really need is a relook at their own strategies regarding shareholder returns and investments for new opportunities such as digital services. Perhaps, this may happen only with an activist investor breathing down their necks