New Delhi: Cognizant Technology Solutions Corp. is back to what it did best for most of its 24 years: focusing on growth. According to its mid-term strategy beginning next year, the Nasdaq-listed company expects to grow between 7% and 11%, retain its 19% operating margin and promises to spend at least $600 million on acquisitions every year.
Growth, not profit, is Cognizant’s new priority
Cognizant’s new approach is in contrast with its current strategy, which has prioritised profitability over revenue growth. The company was pushed by activist investor Elliott Management Corp. in November 2016 to abandon what it felt was an “antiquated, growth-at-all-costs” business model.
In 2017, Cognizant had promised to improve its profitability to 19% by the end of December 2019.
Last Friday, when Cognizant held its first ever investor day event in New York, the management reaffirmed its stated guidance of improving operating profitability. However, the company said that beginning January 2020, the firm will look to improve its profitability by only 10 basis points every year. It expects organic revenue growth of 6-9% and another 1-2% from acquisitions, translating into 7-11% growth in constant currency terms.
One basis point is one-hundredth of a percentage point.
Finally, the company will spend 25% of its annual free cash flow on acquisitions. “It is clear that Cognizant’s focus is back on getting industry-leading growth as a 10bps improvement profitability is just another way of saying we will retain our margins,” said a Mumbai-based analyst of a domestic brokerage, requesting anonymity.
“We thought the CTSH (Cognizant) analyst event had some positives and negatives. On the positive side, management provided information around the depth of offerings, offered a longer-term margin framework that we think is entirely appropriate (10+bps/year starting in CY20), and it will be moving to GAAP earnings in CY19,” Keith Bachman, an analyst with BMO Capital Markets, wrote in a 16 November note. “On the negative side, we think CTSH implied guidance for CY19 remains a bit aggressive.”
Cognizant’s analyst day was important for four reasons.
One, prioritising profitability over revenue growth had led to heartburn among its investors and analysts. Sample this: Cognizant improved its profitability to 18.3% from 16.1% in January-March 2017, but during this time the company’s year-on-year constant currency revenue growth declined to 6.6% from 11%. Understandably, over the past one year, Cognizant shares have under-performed Nasdaq or the firm’s larger peer Accenture Plc and even smaller Indian rival Infosys Ltd.
Two, Cognizant’s aggressive outlay for acquisitions means that the company’s approach of investing in digital technologies is similar to its larger rival Accenture. For now, none of the home-grown IT firms, including Tata Consultancy Services Ltd, Infosys or Wipro Ltd, have shared any spend reserved for acquisitions as part of their capital allocation policies.
Three, Cognizant’s analyst day event was similar to the annual analyst gathering of Accenture. The company shared its strategy on how it is scaling up Cognizant Interactive business. Again, like Accenture, Cognizant too detailed its focus areas in “digital”. In addition to Cognizant Interactive, the company expects to generate more revenue from analytics and artificial intelligence platforms.
Four, Cognizant’s strategic outlook over the next five years should assuage investor concerns amid news that the company is in the midst of finding a successor to CEO Francisco D’Souza sometime next year.
“The issue of succession planning is the responsibility of the board and we are continuing to assess and continue to make plans on that topic. We have nothing to announce at this point,” D’Souza told analysts on 30 October after Cognizant declared its third-quarter earnings.