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Is Cognizant’s guidance realistic?

Is Cognizant’s guidance realistic?
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First Published: Sun, Feb 15 2009. 11 16 PM IST

Updated: Sun, Feb 15 2009. 11 16 PM IST
US-headquartered Cognizant Technology Solutions Corp. reported better-than-expected results for the December quarter. Revenue grew by 25.5% year-on-year to $753 million (about Rs3,700 crore) and operating profit rose by 34.4% to $142.7 million.
For the year ended December, revenue grew by 32% to $2.82 billion, making it the fastest growing among large information technology (IT) outsourcing companies with an India base.
In comparison, the revenue of Infosys Technologies Ltd grew by 20.2% to $4.68 billion during this period. Cognizant’s superior growth is owing to the relatively high amount it spends on sales and marketing, resulting in deeper client relationships. It forks out 23% of revenue on sales, general and administrative expenses, 10 percentage points more than Infosys. Between 2002 and 2007, Cognizant has expanded revenue at a compounded annual growth rate (CAGR) of 56.3%. Infosys recorded a CAGR of 41.9% during the same period. Other large Indian IT players have grown at even lower rates.
Also See Profit Squeeze (Graphic)
Based on this history, the markets have come to expect a differential of about 10 percentage points between Cognizant’s growth rate and that of large Indian IT firms.
Now that Cognizant has guided for a 10% growth in revenue for the year ending December, it won’t be surprising if other large outsourcing companies report no growth or, worse still, a drop in revenue. But what’s more discomfiting about Cognizant’s guidance for the current year is that it seems to be based on some aggressive assumptions. To start with, the guidance assumes that average billing rates will decline only marginally this year. The company admits that there may be rate cuts for some clients, but not to an extent where the company’s average pricing takes a hit. According to the head of research at a domestic institutional brokerage, that’s a bold assumption given the current environment.
Second, the company’s guidance assumes that growth will pick up from the June quarter. In the March quarter, it expects revenue to drop by 2.4% on a sequential basis but the annual guidance assumes that revenue will grow by 3.6% on an average in each of the next three quarters. Given the uncertainty in the world economy, some analysts are uncomfortable with this assumption. Cognizant had guided for 38% growth for 2008, but ended up with 32% growth owing to the slowdown.
This is not to say that Cognizant’s targets for 2009 are unachievable. But there is a strong possibility of a downside. If pricing takes a hit, as some analysts are predicting, even profit margins would be squeezed. Besides, there could be a rise in bad debts. As far as India-based IT players go, what all this means is that the possibility of a drop in revenue and profit in 2009 looks greater.
Shares of Cognizant and Infosys have halved in the past two years, reflecting the pain the industry is expected to face in the near-term. If the IT firms are not able to achieve their comparatively low guidance targets, there is likely to be a further correction in share prices.
Graphics by Ahmed Raza Khan / Mint
Write to us at marktomarket@livemint.com
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First Published: Sun, Feb 15 2009. 11 16 PM IST