Cognizant has improved margins, but investors want higher growth
Cognizant’s revenue amounts to as much as 78% of TCS’s revenue, which shows how much its shares have fallen out of favour
In the trade-off between profitability and growth, Cognizant Technology Solutions Corp. has always favoured the latter, except in the past two years. This was after activist investor Elliott Management Corp. questioned the company’s “growth-at-all-costs-mindset” in late 2016. The company took some of Elliott’s suggestions on board, and ended up improving profit margins by about 200 basis points in the past two years. The improvement in profit margins meant that Cognizant’s earnings were growing ahead of peers, most of who were reporting a decline in margins.
One hundred basis points equal one percentage point.
Till early this year, investors didn’t seem to mind the fact that revenue growth was sluggish, since competitors such as Tata Consultancy Services Ltd (TCS) and Infosys Ltd were struggling for growth as well.
But growth has picked up considerably at TCS in the past two quarters, while things seem to be going in the reverse direction at Cognizant. In the September quarter, TCS grew revenues by 11.5% in constant currency terms, or after eliminating the impact of exchange rate fluctuations. Cognizant’s revenues grew 9% last quarter, and are expected to grow by 8.8% at best in constant currency terms in the December quarter. The company even cut its annual revenue growth guidance considerably.
What’s more, Elliott appears to have exited its position in the company early this year, suggesting most gains from operational efficiencies have already been extracted. As the chart above shows, Cognizant shares have underperformed considerably this year. In February, the company’s market capitalization was roughly at 60% of TCS’s market value; it’s now down to around 40%.
The company’s revenue, meanwhile amounts to as much as 78% of TCS’s revenue, which shows how much its stock has fallen out of favour.
Cognizant has blamed its woes on sluggishness in spending on traditional services by European banks. So even though digital services are growing at a fast clip, revenues from all banking and financial services clients grew by less than 3% year-on-year last quarter. This segment accounts for about 36% of total revenues and it’s little wonder overall growth numbers are under pressure.
But analysts also worry that the pruning of selling and marketing expenses has hurt growth. “The growth impact of rationalization in selling expenses is visible,” analysts at Nomura Research wrote in a note to clients in August.
While investors have already lost patience, news reports suggest that the Cognizant board is considering a change in leadership, as early as next year. It does look like the current leadership is struggling to balance the tension between driving growth and profitability.
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