BackIs the law of large numbers catching up with IT firms?
Even if Cognizant ends up adding more revenue than it did last year, its growth might still be lower in percentage terms
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For all the talk of 2014 being a much better year for information technology (IT) services companies, Cognizant Technology Solutions Corp.’s guidance for the year was rather disappointing.
Revenue is expected to grow 15.9%, lower than the 19% growth in 2013 after accounting for acquisitions. Cognizant is the second largest IT services company with offshore facilities in India, and is the first to give annual growth guidance.
To be sure, the company’s post-results commentary was upbeat.
The industry is experiencing a once-in-a-decade shift in technology towards social, mobile, analytics and cloud; the Internet of Things; machine learning, etc., and this creates significant opportunities for his firm, chief executive officer Francisco D’Souza said on a call with analysts.
It’s clear that there is a disconnect between the commentary and the guidance. This is because of the company’s conservative approach . A year ago, it had said it would show organic growth of 15.8%, but ended up with an expansion of 19%.
But another major factor is what the company refers to as the law of large numbers. In 2013, Cognizant added $1.4 billion in incremental revenue to notch up 19% growth. To achieve the same level of expansion, it needs to add $1.68 billion in incremental revenue in 2014.
In other words, even if the company ends up adding more revenue than it did last year, its growth might still be lower in percentage terms. This is a good reality check for investors in Indian IT stocks, who have been pricing in an increase in percentage growth rates.
Cognizant’s December quarter performance disappointed as well. Adjusted for the impact of an acquisition last quarter, revenue grew just 1.7% sequentially. To be sure, the September quarter represented a large base, with revenue having grown 6.7%. Still, it’s important to note here that year-on-year organic growth slipped more than a percentage point to 19% last quarter.
All this is not to say that demand for IT services has ebbed. On the contrary, D’Souza said the increase in discretionary spending since the middle of 2013 should continue this year. Offshoring companies are benefiting from the dual mandate customers are pursuing of optimizing costs in order to free dollars for investing in growth opportunities, he pointed out. In addition, customers’ IT budgets have risen moderately on an average, which is better than previous years, when most budgets were flat or marginally up.
Yet, despite all this, investors might have to get used to a gradual tapering of growth in percentage terms, thanks to an already large base. Before the results announcement, Cognizant traded a price-earnings multiple of 24 times 2014 earnings. It has now corrected to around 23 times, which still looks high, considering that growth is expected to be in the teens.
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