Deals

Brooke Sutherland is a Bloomberg Gadfly columnist covering deals. She previously wrote an M&A column for Bloomberg News.

Elliott Management Corp. has a Trump card in its plan for Cognizant Technology Solutions Corp.

The activist investor on Monday disclosed a stake in Cognizant and called on the provider of information-technology outsourcing services to lift its margins and do a big share buyback, among other initiatives. Elliott's criticisms center on Cognizant's policy of reinvesting whatever profits it earns above a 20 percent operating margin back into the business -- a relic of its 1998 IPO. That was all well and good when sales were expanding by at least 15 percent a year, but growth has slowed and the profitability gap with Cognizant's peers has widened, leaving the company trading at a discount to the likes of Accenture and Tata Consultancy.

Playing Catch-Up
Even though Cognizant is on track to grow faster than its peers, its valuation lags.
Source: Bloomberg
Data doesn't account for the pop in Cognizant's stock on Monday.

Basically, Elliott wants the $35 billion company to realize it's not the whippersnapper upstart it once was and make operational improvements that have been a long time coming. The proposals for a rethinking of Cognizant's cost structure and a shift toward bigger shareholder payouts make sense -- so much sense that they're not all that original. Sell-side analysts have been calling for similar changes for months. Elliott quotes nine of them in its press releases and acknowledges these ideas are not new. And yet shareholders still got excited enough to push Cognizant's shares up as much as 9.9 percent.

On the Rocks
Cognizant shares were pressured by Trump's election and then buoyed by news of Elliott's involvement.
Source: Bloomberg

Elliott is far from the first activist investor to jump on an idea that was already out there -- or in some cases already being carried out by management. As opportunities wane for activists, sometimes their best bet is to use the soapbox they've earned to drum up public interest in a proposal, original or not. Even if it wasn't the first to come up with the idea, Elliott clearly has more power to bring about change than the sell-side analysts, and with a more than 4 percent holding that ranks it in the top five of the shareholder register, its voice is stronger than most minority holders. There's reason to believe it can actually get something done here. And with more than $20 billion in value creation on the table (by Elliott's math), why the heck not get involved?

The other factor working in Elliott's favor is the prospect of a Donald Trump presidential administration.

Cognizant's stock, like that of many tech companies, has been volatile in the wake of his surprise victory, but as of last week it was down about 3 percent. Information-technology outsourcers rely on H-1B visas to bring in inexpensive talent from other countries -- a program that the president-elect has at times criticized for taking jobs away from Americans. Should Cognizant's allocation of H-1B visas be cut in half, the company would face roughly $89 million of additional costs and an 11 cent hit to its earnings per share, James Friedman of Susquehanna International Group estimated in a report earlier this month.

As with most of Trump's proclamations, the policy outcome is hard to predict. He has flip-flopped on H-1B visas before and may very well do so again or take less of a hard-line approach than Friedman's model suggests. Cognizant has also already taken steps to reduce its dependence on foreign workers, and it's possible the tax benefits it would get under a Trump-led overhaul would outweigh any hit from the visa program. But it's nevertheless a risk that adds more urgency to the kind of EPS boost a streamlined cost structure and generous share repurchases can provide. Elliott notes that its plan to bring Cognizant up to an adjusted operating margin of 23 percent leaves plenty of flexibility to respond to regulatory changes.  

Combine that with Cognizant's slowing revenue growth and there's no time like the present for the company to start taking seriously the proposals of its analysts, er, I mean Elliott.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

To contact the author of this story:
Brooke Sutherland in New York at bsutherland7@bloomberg.net

To contact the editor responsible for this story:
Daniel Niemi at dniemi1@bloomberg.net