How Cognizant's Digital Evolution Was Derailed By An Activist Investment Firm

Earlier this month, Cognizant shocked the IT and investment community when it revised its revenue growth target from the 7-9% band announced in February, to an abysmal and all-time company low of 3.9-4.9%. 

In fact, the last three years have been marked by single digit growth as well, but it's never been as low as the most recent quarter. Even after the debilitating financial meltdown in 2007-8, Cognizant was still able to post revenue growth figures of 16% in 2009 and 40% in 2010, according to a LiveMint report.  

"Cognizant had a challenger strategy," founder of technology research and advisory firm Constellation Research, Ray Wang said in the report. "The key was that they had less rules, less bureaucracy to do the right thing, and that led to explosive growth."

Hard to imagine that this is what the growth powerhouse has become, especially after the way it galloped past competitors with compound growth rates of 48% between 2004 and 2008, and 28% between 2009 and 2013, which left everyone else far behind in the dust. 

So what went so horribly wrong?

According to many well known analysts and observers of the IT landscape, Elliot Management, an activist investment firm known for taking positions in undervalued companies to ultimately pressure change, drove Cognizant's stock up and exited, with one analyst labelling the move as "destructive activism". A former CFO of Infosys, meanwhile, called it a "distraction" and wondered if the firm could ever get its DNA back.

See: IT leader Cognizant evolves AI beyond 'hill climbing'

It all started around 2016 when Elliot took a 4% stake in the company and promptly dispatched a letter to Cognizant telling them that they needed to change course. 

"Over the last five years, Cognizant has underperformed [compared to] its core IT services peers by 83% despite growing revenue at a 22% CAGR (compound annual growth rate) versus the peer average growth of a 16% CAGR over the most recent fiscal quarters," Elliot Management partner Jesse Cohn wrote in his letter to Cognizant's board. 

Elliott's value enhancement plan basically involved shifting focus away from Cognizant's hyper-growth to improving profitability. This meant a more robust adoption of automation, firing employees, and transitioning towards a higher margin digital business. It also mandated a $2.5 billion share repurchase that was to be completed within months.

Sure enough, Cognizant's profit margins improved considerably from 16.1% to 18.3% within three months from January to March 2017, but the predictable downside was that the company's year-on-year constant currency revenue growth tanked from from 11% to 6.6%. 

"You had a CEO focused on EPS and dealing with activist investors just at a time when they needed to be focused on external wins instead of internal politics," Wang said. 

At almost exactly the same time, Cognizant also became embroiled in a bribery scandal that knocked the wind out of its sails. US prosecutors filed criminal charges against Cognizant's then-president Gordon Coburn and then-chief legal officer Steven Schwartz for a $2 million bribe that was given to Tamil Nadu government officials to obtain building permits for a campus in Chennai.

Cognizant spent at least $60 million dollars investigating the case, and it paid a fine of $28 million to US authorities to settle the case. To rub salt into Cognizant's wounds, Elliot Management exited its position shortly after, gaining a 50% profit from its initial 4% stake worth $1.4 billion.

See: Accenture adds 10,000 more Microsoft-focused consultants to its practice

Would Cognizant have evolved differently without Elliot's interference and exhortation to squeeze money from existing businesses? Phil Fersht, CEO of HFS Research, said the firm at one point had given digital leader Accenture a run for its money but "with the impact of Elliott, the firm struggled to make investments to keep up and the leadership appeared tired and burned out in recent times."

A ZDNet article published at the time of Elliot's open letter in 2016 presciently predicted the carnage that came to be. Cognizant had once been a pioneer at thinking digitally and looking for acquisitions that added value to their evolution towards a digital firm. But with the recent dismal forecast revision, it appears that some more work is yet to be done if it is to undo the damage sustained over the past few years.

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