Cognizant bows to investor pressure on costs

As the Nasdaq-listed IT firm paves the way for layoffs under pressure from investors, analysts say the move is both soothing and disconcerting

The annual appraisal at Cognizant Technology Solutions this month came as a surprise to many. Not only was their performance under greater scrutiny, but at the end of the review process, some were left unsure of their future.

As many as 10,000 employees are expected to be laid off. Many will lose their job to automation. Like others in the industry, Cognizant, too, has been trying to reinvent itself and focus on highend projects that require specialised skills. The Nasdaq-listed solutions provider has 260,200 employees, and, according to sources in the company, up to 2.5 per cent could lose their job, although employees think the number could be higher.

Cognizant has been under pressure from investors to shore up margins. Investors want to see the company boost profitability, deliver growth and return cash to shareholders. Last month, Cognizant reached an agreement with activist investor Elliott Management, which holds 4 per cent stake, to boost its non-GAAP operating margins from 19.5 per cent in 2016 to 22 per cent by 2019 by streamlining costs, improving operational efficiency and aggressively employing automation to optimise traditional services.

Elliott wanted a $2.5-billion buyback, dividend payouts and other operational changes. In tune with this, Cognizant announced it would return $3.4 billion to shareholders over the next two years through share repurchase and dividends. While the company has in the past, too, used the share buyback platform, it will be paying shareholders dividends for the first time.

As part of this plan, the company expects to commence a $1.5-billion accelerated share repurchase in the first quarter of 2017-18, initiate a regular quarterly cash dividend of $0.15 per share commencing in the second quarter of 2017, and repurchase shares of $1.2 billion in the open market during 2017 and 2018. Beginning 2019, the company plans to return approximately 75 per cent of its US free cash flow on an ongoing basis to shareholders. Cutting costs

Cost rationalisation is a big part of this exercise. “We will leverage our scale to improve cost in 2017 and 2018 through cost optimisation efforts and intelligent sourcing,” said Karen McLoughlin, Cognizant’s chief financial officer, during the company’s February earnings call. “And we will aggressively use automation to drive the optimisation of traditional offerings such as application, infrastructure, and process services.”

While the axe is set to fall on headcount, employee remunerations are showing the strain too. The variable component of pay has been slashed to 95 per cent of the 2015-16 payout, which is significantly lower than the usual 150-200 per cent earned earlier.

Analysts say the job cuts are directly related to the company’s use of both intelligent and robotic process automation to eliminate human contact. This not only frees Cognizant to reduce its cost structure by slashing its expendable workforce, but also enables the company to take top performing employees and up-skill them to work on “higher-value” projects.

Ryan Blanchard, analyst, Technology Business Research, who tracks Cognizant closely, however, believes the lay-offs are nothing out of the ordinary and Cognizant makes similar headcount reductions each year.

“Context is the key with this development, as 2016 saw Cognizant increase its global headcount by roughly 17 per cent, an addition of about 38,500 employees from the end of 2015 to the end of 2016. So, while the reported cuts, which I believe are around 6,000 layoffs but am not sure on the exact figure, is actually well-offset by the additions made during the year. Also, there could be some cutting related to eliminating redundancies within recent acquisitions that are now fully integrated,” he says.

According to Blanchard, apart from vendors looking to eliminate costs related to what are largely perceived as low-value, non-critical tasks in operations, the other factor behind jobs cuts is the push to higher-margin engagements with clients, which typically involve more in-person collaboration and interactions with the client and more skilled employees that are familiar with digital technologies and agile methodology.

“I do think this is the way forward for Cognizant and its peers like TCS and Wipro that are heavily investing in and seeing traction for their respective artificial intelligence-backed automation tools such as Ignio and HOLMES,” he says.

Investors cheer move

Clearly, investors have given their support to this strategy. The company’s stock climbed $0.50 (0.85 per cent) to $59.06 a day after the news about layoffs. What gives investors added confidence is Cognizant’s strong financials. Its revenue has quadrupled since 2008, and the company is growing at a faster pace compared to Indian peers, including Infosys and Wipro.

In 2016, revenue increased to $13.49 billion, up 8.6 per cent from $12.42 billion in 2015. Full year 2017 revenue is expected to be in the range of $14.56 billion to $14.84 billion. The Company finished the quarter with approximately $5.2 billion dollars of cash and short-term investments.

There are other things investors like about Cognizant. “Its businesses are very sticky and require very little capital — people are hired as needed — and thus it has a very high return on capital,” says Vitality Katsenelson, CIO at Investment Management Associates.

Blanchard, however, says the decision to address the concerns of Elliot are both soothing and disconcerting, depending on how one looks at it. On the one hand, he says, it shows that Cognizant is receptive to its shareholders, willing to make necessary adjustments to stay ahead in the market, and focused on improving its valuation.

The concerning part, however, is the risk that such efforts to assuage shareholder concerns could limit its ability to reinvest in the company’s portfolio and other strategic initiatives, including but not limited to acquisitions.

The company has been steadfast in its dedication to reinvest at least 20 per cent of its operating profit back into initiatives to grow the business. “At a time when growth is consistently slowing, that reinvesting methodology could be key to remaining competitive in a rapidly evolving market,” he says.

He adds that while not much is likely to change in Cognizant’s strategy, its performance will largely be dependent on its willingness to acquire both revenue and portfolio growth moving forward.

As the industry changes, the demand for cost rationalisation is not limited to IT vendors alone — there is also demand from clients for similar investments and this will shift the buying and delivery models within the industry. The near future will be focused on using analytics, cloud-based solutions and highly-sophisticated automation tools to streamline operations, cut costs and expedite time to market for clients focused on their bottom lines, he avers.

While the axe is set to fall on headcount, employee remunerations are showing the strain too