Elliott Management calls for IT outsourcer to boost profit, return cash to shareholders

By Austen Hufford and David Benoit

Activist investor Elliott Management Corp. called for change at Cognizant Technology Solutions Corp., a $34.6 billion IT-outsourcing firm whose growth prospects have been upended by the rise of cloud computing.

Elliott said Monday it held a 4% stake in the company worth $1.4 billion -- the fund's largest-ever initial stock purchase for an activism campaign, according to FactSet. In a 16-page letter, Elliott said Cognizant should boost profitability and return cash to shareholders instead of focusing on revenue growth.

Cognizant said it "welcomes open communications with all of its shareholders and values their input" and that it expects to respond to the letter "in due course." The company's shares rose 6.9% in New York Monday.

Elliott noted that Cognizant hadn't updated its profit-margin targets to reflect its larger size. Revenue at Cognizant, now one of the largest IT-services firms, rose to $12.4 billion last year from $886 million a decade earlier.

Analysts at William Blair wrote Monday that Elliott's demands were consistent with other investors' desire "for stronger capital returns in the face of a changing IT-services industry," though the analysts had recently downgraded the stock partly on their belief Cognizant management "continued to be inflexible."

Cognizant, of Teaneck, N.J., provides outsourcing, consulting and technology services to the health-care, financial services, manufacturing and retailindustries. Spun out of Dun & Bradstreet in 1998 Cognizant has grown, partly through acquisitions, into a Fortune 500 company.

The outsourcing industry is changing rapidly from an era that primarily relied on low-cost labor overseas to one that has increasingly focused on digital automation and cutting humans out of the equation.

Cognizant has fared relatively better than some Indian outsourcing providers such as Infosys Ltd. and Wipro Ltd. in this transition as it has overtaken both competitors in revenue during the past five years. While Cognizant is based in the U.S., most of its employees are in India.

Like other IT-services companies, Cognizant also has been pressured by businesses' shift toward the cloud, in which software and IT services are accessed over the internet from third-party providers.

Hearst Corp. said it hired Cognizant two years ago to help it reduce its own in-house data center infrastructure, but that its services were no longer needed. "We are not working with them now as we are basically doing most of it in house," Hearst Chief Technology Officer Philip Wiser said.

Mr. Wiser said the cost of maintaining IT operations would continue to decrease as it becomes cheaper for companies such as Hearst to develop internal applications thanks to the rise of cloud-based applications that require little or no customization.

Elliott has made a practice of finding older technology companies whose growth has slowed as they transition to middle age. Often, Elliott calls for more capital returns and reduced investment, arguing managers have gotten distracted trying to expand and should pay back investors instead.

At Cognizant, Elliott is giving a tempered version of its argument, careful not to call for actual employee or cost cuts, but instead a slower expansion and stricter margin targets that would free up capital to go back to investors. To enforce their ideas, Elliott is suggesting new directors and a new board committee to oversee operations. It also wants a change to executive compensation that would tie pay to earnings growth and total shareholder return instead of to revenue growth.

The fund also wants Cognizant to implement a $2.5 billion share-repurchase plan and start paying its shareholders a dividend.

While the letter is complimentary of management, Elliott does set up a timetable that could lead to a shareholder fight early next year. The fund asks Cognizant to announce changes by an earnings call in February. A deadline for unhappy shareholders to nominate directors looms shortly afterward in March.

Elliott also notes that both board members and management have held long tenures at Cognizant. Chief Executive Francisco D'Souza has been with the company since before it was spun off and became CEO in 2007. A former company CEO also sits on its board.

Elliott said Cognizant has maintained its operating-margin target of 19% to 20% for nearly two decades despite the company's growth.

While annual revenue at Cognizant continues to grow in the double digits, it remains below the 50% growth seen in the earlier part of this century. Instead of prioritizing revenue growth, Elliott wants Cognizant to focus on boosting profitability and shareholder returns.

In August, Cognizant cut its revenue forecast for the year, citing macroeconomic headwinds. In September, it said it was conducting a probe into whether payments in India violated a federal anti-foreign-corruption act, and it also said its president resigned.

Cognizant has ramped up hiring, adding 36,500 employees in the year ended September as it added to its service delivery staff. In all, it had 255,800 employees.

Rachael King contributed to this article.

Write to Austen Hufford at austen.hufford@wsj.com andDavid Benoit at david.benoit@wsj.com

(END) Dow Jones Newswires

November 29, 2016 02:47 ET (07:47 GMT)

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