Can Cognizant Get Its Act Together?

After pushing Samsung Electronics to simplify its complicated ownership structure, improve its corporate governance by adding three independent directors, list itself in the US and pay shareholders a special dividend, activist hedge fund Elliott Management has turned its attention to New Jersey-headquartered IT services major Cognizant Technology Services. After picking up over 4% in the company for $1.4 billion, Jesse Cohn, the head of US activism at Elliott sent a 16-page letter to the Cognizant management drawing out a plan on how it can enhance return to shareholders. Cohn is known to shake up underperforming tech companies ranging from EMC, Citrix to Life lock. He believes that Cognizant can easily be worth $8090 per share by the end of 2017, a gain of 45% to 64% in a single year, if the company implements some of the fund’s recommendations. One of its biggest grouse against the IT services major has been the fact that Cognizant continues to swear by a strategy of choosing growth over profitability from nearly two decades since it started out as a contender.

- Kripa Mahalingam

RENEWAL STRATEGY

While the fund acknowledges that the strategy served the company during its initial growth years, the changing dynamics of the industry calls for a change in strategy. Cohn points in his letter that while revenue has increased by a factor of 140x since the company went public in 1999, the margins have never moved beyond the targeted band of 19-20% which means the company didn’t see any benefits of operating leverage. Elliott points out that despite a similar business mix and gross margin profile to its two closest peers (TCS and Infosys), Cognizant has an operating margin that is 750–850 basis points lower on a comparable basis. The fund believes its value enhancement plan that aims at improving the overall efficiency in the company without sacrificing growth could see the margin move to 23% by 2018. The fund also wants the company to pay out dividends that will give shareholders a yield of 1.5% and make a commitment of returning 75% of its annual free cash flow through share buy backs besides making a stock buyback of $2.5 billion using $1 billion of cash on hand and the rest financed through debt. Currently, the company has $4.9 billion of cash on its books, doesn’t pay its shareholders any dividend and only buys back shares to make up for any equity dilution due to vesting of stock options. The fund also calls up for a shake-up of the company’s board and senior management saying that it was time for directors with some new perspective and skills to come in, given the continued under performance of its stock. It pointed out that more than half its directors have been on the board for more than nine years and two thirds of its named executives have been with the company for more than 18 years.