Markets
Coforge faces Street wrath on lack of guidance, Cigniti acquisition
Summary
- Lack of revenue guidance and delay in extracting cross-sell synergies from the Cigniti deal amid tough market conditions have prompted analysts to lower their earnings estimates for Coforge
Coforge Ltd’s investors grappled with too many things on Friday. Firstly, the March quarter (Q4FY24) results did not bring any cheer. But more disappointing was the lack of clear revenue growth guidance for FY25, a break from the company's usual practice, which raised concerns about future revenue visibility.
Amid this, Coforge has decided to acquire 54% stake in Cigniti Technologies through a cash-cum-stock swap deal and will eventually merge it post the required approvals. Cigniti Technologies is an artificial intelligence (AI) and IP-led digital assurance and digital engineering services company.
With this deal, Corforge aims to scale its retail vertical and expand geographical presence. Further, Cigniti acquisition will help Coforge grow into a $2 billion firm by FY27 and improve margin by 150-250 basis points over the same period, the management said.
This is a large acquisition for Coforge. The worry is that it can be a drag on earnings as the demand environment remains tough. Usually, it takes longer for large acquisitions to eventually reap the potential benefits on revenue and deal pipeline. In effect, Coforge’s shares fell as much as 10% on Friday.
“Amid pressure on existing business, its acquisition adds to execution risk. Also, realizing synergies amid a weak demand environment may be an uphill task," said analysts from Jefferies India in a report on 2 May. “Continued disappointment on margins, weaker growth, and acquisition-related uncertainty in our view warrant a derating of Coforge," according to the analysts.
To be sure, Coforge has exhibited solid execution capabilities in the past, and this deal is likely to be earnings per share accretive, but extracting cross sell synergies may not be a cakewalk in the current backdrop. So, analysts are cautious.
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“We have assumed that the combined entity will do well but fall short of its $2 billion goal by a tad and that margin expansion will come in at the lower end of 150-250 bps goal," said a Nirmal Bang Institutional Equities report.
Meanwhile, in Q4FY24, sequential constant currency (CC) organic revenue grew 1.9%, lower than some analysts’ estimates. For FY24, the company delivered revenue growth of 13.3% year-on-year, closer to the lower end of its guidance of 13-16%. Earnings before interest and tax margin at 14.4% was also lower than anticipated.
Though the management expects all verticals to witness growth, it acknowledges that the demand environment remains challenging amid macro uncertainties. The total contract value of new order intake stood at $774 million in Q4 versus $354 million in Q3FY24. The executable order book over the next 12 months is $1,019 million compared with $974 million in Q3. However, in the absence of revenue guidance, analysts at JM Financial Institutional Securities now estimate 9% USD FY25 revenue growth for Coforge versus 15.7% earlier.
This combination of factors prompted analysts to lower their earnings estimates for Coforge, and some brokerages also reduced the stock's target price.
The stock has declined nearly 27% so far in 2024 compared to an 8% drop in the Nifty IT index. Ongoing caution among clients regarding discretionary IT spending is expected to impact midcap IT companies more severely than larger peers. According to Bloomberg data, Coforge's shares are trading at a price-to-earnings multiple of around 25 times for FY25, which is considered high against the current backdrop.
