By Eric Wahlgren In India, entry-level programmers and other information-technology graduates earn between $5,000 and $7,000 a year -- about one-tenth of what their U.S. counterparts make. Thanks in part to wage disparities like this, Cognizant Technology Solutions (CTSH), which employs IT professionals in India to manage and develop software applications for companies around the globe, can reduce certain IT costs for corporate clients by 20% to 50%, Wall Street analysts say.
MetLife (MET), JP Morgan Chase, and others with huge IT needs have hired Cognizant, driving its profits up 50% in 2002. And as companies continue to hop on the outsourcing bandwagon, Cognizant expects its earnings per share jumping an additional 52% in 2003 on sales of $354 million. (Analysts will get a better idea of its progress toward this goal when it reports third-quarter earnings on Oct. 21).
"BEST EXECUTION." Cognizant is hardly the only company to capitalize on the offshore outsourcing trend, as U.S. and European companies alike rushed to trim costs during a prolonged economic slump. Wipro (WIT) and Infosys Technologies (INFY) also come to mind. But investing pros say Cognizant, which has seen year-over-year revenues grow by at least 50% in the last three quarters, stands out.
"It has without question the best revenue momentum and the best bottom-line execution in the group," says Ashish Thadhani, an analyst with Brean Murry & Co. in New York, who has a buy rating on the stock. (Neither Thadhani nor his firm own Cognizant shares.)
The stock has already benefited from the company's superb performance, gaining 66% so far this year, after adjusting for a three-for-one share split. It closed on Oct. 9 at $40.09, surpassing Thadhani's target price. It's now trading at about 49 times its expected 2003 earnings, a price-to-earnings ratio well above the multiple for the benchmark Standard & Poor's 500-stock index.
HIGH EXPECTATIONS. Although it's near the $41.51 high in its 52-week trading range, the stock still has potential for above-market returns, say the bulls. "Based on our view of attractive long-term growth dynamics, significant revenue visibility, and anticipated continued positive earnings surprises, we believe the valuation premium to the market is warranted," writes S&P analyst Massimo Santicchia, who has an accumulate rating on Cognizant and a current target price of $43. (Like S&P, Santicchia doesn't own any Cognizant shares.)
Mayank Tandon, an analyst with Janney Montgomery Scott in Boston, isn't quite as bullish. He fears the stock could be punished if financial results fail to live up to Wall Street's high expectations. "Even in the face of the very strong fundamentals, there's a potential of headline risk," says Tandon, who has a hold rating on the stock. But he says "we are very comfortable" buying Cognizant in the low- to mid-$30 range. (Tandon and his firm own no Cognizant shares.)
Investors should keep Cognizant on their radar for several reasons, Tandon adds. It's about half the size of its bigger competitors, making it a nimbler player in the field, he says. Cognizant also specializes in providing IT services to businesses in financial services and health care, two sectors that seem especially eager to adopt offshore IT outsourcing. "It gives them a little bit of edge in their growth," he says.
STILL GROWING. What's more, Cognizant "has had the most success in building strong customer relationships," Tandon says. For starters, it's headquartered in the U.S. - Teaneck, N.J. - rather than in India, where many of its competitors are based. That's "an added comfort factor" for top clients, Thadhani says. (About 30% of Cognizant's team, including top management and sales staff, is in the U.S. or Europe, while the remaining 70% is in India.)
It also has a strong customer focus, Thadhani adds -- with a practice of assigning senior-level execs to lucrative "strategic accounts." These accounts, which can bring in between $5 million and $30 million in revenues, have been growing at a good clip, he adds.
Cognizant got its start in 1994 as an in-house technology-development center for business information outfit Dun & Bradstreet (DNB). It went public in 1998 and has broadened its scope, building out its active customer base in its core business to about 110 in the most recent quarter. Among its projects, Cognizant developed and now maintains RadioShack's (RSH) supply-chain system to help the retailer keep its shelves stocked with the products consumers want, says Larry Gordon, Cognizant's vice-president for corporate marketing.
WAGE CONCERNS. Future prospects are bright. "The corporate mind set of wanting to get the work done at the lowest possible cost isn't going to be broken," figures management-consultant Peter Cohan, the author of Value Leadership (Jossey-Bass/Wiley, October, 2003). Cognizant keeps growing, with plans to hire as many as 1,300 new employees by the end of 2003. That would expand its global work force as much as 17%, to 9,000. "That's a very good sign of health at a company," says Cohan.
Of course, analysts have some concerns. "Wages could come under pressure," Tandon says. Some 250,000 students in India who graduate with IT training every year represent a plentiful supply of high-skilled, low-cost labor, he adds, but that could change over time, as demand for these grads continues to increase.
Tandon says he's also concerned about price pressures, as competition in the field heats up. Recently, pricing in the IT-outsourcing industry has stabilized after a drop in billing rates, he says. "But pricing in the industry long-term remains an issue," says Tandon.
STRONG "PIPELINE." Cognizant is in a "quiet period" ahead of its third-quarter earnings release and declined to comment on its future business. But Kumar Mahadeva, chairman and chief executive, said in a July 22 conference call with analysts that unlike other offshore outsourcers, Cognizant hasn't had to cut prices. And it's confident it can maintain its 19% to 20% operating margins, he added. In the same conference call, a company representative said the labor supply appears to tightening slightly, but that it hasn't had an effect on wages yet.
Though Cognizant couldn't comment on its stock price, Mahadeva during the call said the company is "growing faster than its offshore peers" and that its "pipeline is the strongest it has ever been." At current prices, Cognizant stock indeed may not be the best bargain in the market. But investors interested in this sector would likely be getting a proven fast-grower in a rapidly expanding industry. Wahlgren covers financial markets for BusinessWeek Online in New York