Activist hedge fund, leadership shift leave imprint on Cognizant

Once considered a worthy competitor to the likes of Accenture and IBM, investors of Cognizant got a rude shock last week when the company guided its worst-ever revenue growth since inception. The market was not able to come to terms with the changes, given that the top management of the US-based information technology (IT) services firm had painted a rosy picture on its growth prospects just a quarter back.

Explaining the rationale behind such a drastic shift, industry experts said the change in the business model, with focus on margins after activist hedge fund Elliott came on board, seemed to be the major contributor towards this downturn. Moreover, the leadership transition, with the founders stepping down from executive roles and higher concentration in banking & financial services (BFS) and health care in Cognizant’s overall portfolio, could be seen as the other driving forces.

“The activist investor Elliott tried to change the DNA of the company. The DNA of Cognizant is to be very aggressive in the sales front and to win large deals at a lower margin. That’s how it is getting superior growth than the industry (average),” said V Balakrishnan, chairman of Exfinity Venture Partners & former chief financial officer and board member of Infosys. “When Elliott came, it changed the business model and forced Cognizant to focus on margin. That has affected revenues somewhat.”

In the last 15 years, Cognizant has posted revenue growth surpassing that of the overall industry average and that of its Indian peers. During the 2004-08 period, the India-origin firm posted a compound annual growth rate of 48 per cent, while between 2009 and 2013, it was at 28 per cent. Even during 2014 and 2015, revenue growth rates were 16 and 21 per cent, respectively.

The Nasdaq-listed firm faced its first growth bump in 2016, when growth fell to the 8.6 per cent level. This was the year when US hedge fund, Elliott, first disclosed to the US exchanges that it had 4 per cent stake in Cognizant. Subsequently, Elliott constantly prodded Cognizant to shed its high growth model and swing towards profitability aspects.

In February 2017, Cognizant succumbed to Elliott’s demands and decided to focus on high margin businesses such as digital services, apart from rationalising its staff with the adoption of automation. It also committed $3.4 billion worth of share repurchases and dividends over two years.

“Cognizant had to restructure its consulting practice, reduce non-billable consulting resources, which negatively impacted its ability to chase higher-margin consulting-led engagements. At the same time, reduced investments in the business curtailed its ability to spend on IP and acquisitions also negatively affected its competitiveness,” said Hansa Iyengar, senior analyst at London-based Ovum Research.

Though the operating margin of the firm improved to 17.4 per cent last year — a 60-basis point expansion over 2017 — it began to take its toll on revenue growth.

The leadership transition at Cognizant has also contributed towards the recent slowdown in growth. With Founder & Chief Executive Officer (CEO) Francisco D’Souza moving to a non-executive role and Rajeev Mehta leaving the company, the connect between the clients and the company became weaker.

“It seems like the Infosys’ moment of Cognizant. When the founders move to non-executive roles and old hands leave the firm, with an outsider taking over as CEO, the company has to go through some transition pangs,” said an industry expert.

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