Cognizant tests growth acceleration theory, patience of investors
While there was excitement initially among Cognizant investors about a move to improve profit margins and increase payouts to shareholders, the difference in sequential growth rates vis-à-vis peers is causing discomfort
Investors of Cognizant Technology Solutions Corp. were in for a rude shock for the second successive results announcement. Revenue growth fell short of Street estimates again, and the guidance for the coming quarters was unexciting as well. The company’s shares fell 7.2% in early trading.
Cognizant reported revenue of $4.01 billion for the June quarter, a growth of 2.56% sequentially. Three months ago, the company had guided that revenues would fall between $4 billion and $4.04 billion. Of course, there were cross-currency headwinds last quarter, which ate into growth in dollar terms. But on the other hand, there was a marginal incremental benefit from a change in accounting policy on revenue recognition. Adjusted for these, it turns out that Cognizant’s year-on-year growth rates are decelerating compared to the levels it reported in 2017.
Why is Cognizant falling behind when peers such as Tata Consultancy Services Ltd (TCS) are reporting acceleration in growth? According to an analyst at a domestic institutional brokerage firm, “The reason Cognizant’s growth rates haven’t picked up has to do with increased involvement of activist investors, which has nudged the company towards profitable growth.”
On a call with analysts, Cognizant’s management said it will focus on high-value, digital work at healthy margins, adding that if some projects don’t meet its criteria, the company has chosen to walk away from them. While profitable growth sounds like a good strategy, investors’ reaction to Cognizant’s results suggest they are unhappy with the level of growth, even if it is coming at higher profitability.
Does all of this mean that activist investor Elliott Management’s involvement at the company is backfiring? The above-mentioned analyst says that this appears to be the case for now. A look at the chart above shows that Cognizant’s market capitalization has lagged TCS’s by quite a distance in recent months. While there was excitement initially among its investors about a move to improve profit margins and increase payouts to shareholders, the difference in sequential growth rates vis-à-vis peers is causing discomfort.
There is hardly any pickup in growth expected either. Growth in the September quarter is estimated at 2.2% at the higher end of the company’s guidance. This is expected to be followed by another quarter of muted growth in the December quarter.
Perhaps Cognizant is still building the blocks of its new strategy, the fruit of which will be seen in the future. All the same, investors are beginning to lose patience.
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