Cognizant Technology Solutions Corp. is a great advertisement for what activist shareholders can bring to the table. Only about seven months ago, Elliott Management Corp., an activist investment firm, advised the company to get rid of its “antiquated, growth-at-all-costs” business model, and focus instead on total shareholder returns. Cognizant announced it will cooperate with Elliott in February, and there are already signs that the partnership is benefiting shareholders.
Cognizant shares have risen 28% since the time Elliott sent its letter, far higher than the 8% return peers such as Tata Consultancy Services Ltd (TCS) and Infosys Ltd have managed during the same time. And as the chart above shows, while in the past Cognizant has largely lagged or run neck and neck with Infosys in terms of market capitalization, it has pulled far ahead in recent months.
The company has already acted on the three major recommendations by Elliott: appoint new board members, improve efficiency and return more cash to shareholders.
In the June quarter, the company’s employee base reduced by about 1.7% owing to a voluntary separation programme as well due to involuntary attrition. Utilization rates improved and margins, after adjusting for severance and stock-based compensation, were more or less stable on a year-on-year basis. Peers such as TCS have been struggling to maintain margins because of pricing pressure in traditional IT services as well as the appreciation in the rupee. In fact, the decline in their margins has investors worried.
What’s more, Cognizant’s revenue growth has also been ahead of its peers. Revenue grew by 8.9% year-on-year in dollar terms, compared to growth of just 5.2% in the case of TCS. True, Cognizant’s revenue this year are aided by some acquisitions made in the past year, although analysts at Nomura Research estimate this to have added around 1-1.5 percentage points to reported growth numbers. Even adjusted for this, growth is higher than peers.
And the company has stepped up its stock repurchase programme, and has started paying dividends after Elliott’s letter.
All in all, investors seem to be rewarded handsomely. The proof of the pudding, of course, is the outperformance of the stock.
Having said all this, Cognizant results also reflect a large challenge being faced by the IT sector. The key banking, financial services and insurance sector grew just 4.1% year-on-year, or a third of the rate at which the rest of the company’s business grew. This clearly doesn’t augur well for the industry. Besides, this is the first time in years that each of the three largest companies in the outsourcing space has reported declines in their employee base.
Clearly, the overall demand environment hasn’t been as muted as it has been in recent quarters. While Cognizant’s focus on total shareholder returns is helping its shareholders, there is no escaping from the fact that the going has become far tougher for the industry lately.