I’ve have had Cognizant on my list of businesses to research for quite some time now, and having watched the stock make its way from the low $40’s right up to the $70 range, I wish I had analyzed this one a lot sooner. It’s never much fun sitting out on such a fat return but it’s even less fun taking a speculative position only to get burned because you didn’t have a good grasp on your business to begin with.
I am going to be taking a close look at Cognizant. My goal will be to collect and interpret any seemingly relevant information for the long term outlook this business, and to then use that data to determine what I believe is an appropriate valuation for this business. In addition, I’ll be interested in the shorter term price performance of the stock and highlight any possible trader [mis]behavior.
To get things started, let’s mention just what it is that Cognizant Technology (NASDAQ:CTSH) actually does. Cognizant Technology Solutions provides custom IT services to Fortune 500 and Blue Chip companies in the U.S. and Asia. MSN Money reports that “Cognizant’s core competencies include technology strategy consulting, complex systems development, enterprise software package implementation and maintenance, data warehouseing and business intelligence, application testing, application maintenance, infrastructure management and vertically oriented business process outsourcing [BPO].”
It is my understanding that basically, Cognizant takes a good thing and makes it better. Their clients are usually large organizations that fall into one of the following categories: Financial, Healthcare, Manufacturing or Retail & Logistics Services. Teams of efficiency experts that are specialized in these fields are able to assist in the client’s long term growth and profitability. Several sources noted that Cognizant routinely develops long-term relationships with the firms they work with. A definite plus if we are looking at the long-term stability of this business.
Additional online sources also note that Cognizant Technologies tailors their services to these specific industries, while utilizing an integrated on site/offshore business model, which combines technical and account management teams located onsite at the customer location and offshore at development centers located primarily in India. Employing some 38,000 professionals across its 27 development centers throughout the world, this is a world class research and development organization aiming to help its clients manage the rapid technological changes of today’s shrinking global economy.
Ok, so now we’ve got an idea of what Cognizant is all about. Now let's see who they are up against. Cognizant faces competition from Wipro (NYSE:WIT), Satyam (SAY), Infosys Technologies (NASDAQ:INFY) and Tata Consultancy Services. Apart from these companies, Cognizant also faces competition from IBM (NYSE:IBM), Accenture (NYSE:ACN), BearingPoint (BE), Sapient (NASDAQ:SAPE) and iGATE (NASDAQ:IGTE). SeekingAlpha notes that consulting and outsourcing is a highly competitive sector, and that these Indian IT firms face problems such as employee attrition and rapid wage expansion. Also that earnings can be impacted by currency fluctuations, and that if expectations of continued high growth aren’t met, stock prices can face sharp declines.
As for Cognizant’s competitive advantage, or moat, Phil Town suggests that there are 3 different moats at work here. We’ve got the “secret” moat in that the individual management teams are highly specialized in their fields. Also that by using the on site/off shore business model, they are able to lower costs of their services by some 20% over non Indian based competitors. So we’ve also got some “price” moat built up here. To widen the moat even further, Cognizant is developing its “brand” moat by having consultants directly assigned on site to the customers location. This all seems reasonable and very much in our favor. However, as mentioned above our competition isn’t limited to IT firms based in the United States. There are numerous other Indian Based IT firms such as Infosys (INFY), Satyam (SAY), and Wipro (WIT). They are some of the other major players in the game, and we’ve got some pretty high hopes of growth for this niche market. A member of our community, George from Fat Pitch Financials, cautions us in that often times the bond between the client and firm may actually be trumped by the bond between the client and individual account manager in the end.
In other words, with a rapidly increasing market and expanding wages, who is to say that key account managers won’t migrate from Indian based IT firm to Indian based IT firm, taking major clients along for the ride? I think this is a valid concern. Furthermore, Cognizant already employs some 38,000 folks. Assuming the analysts growth predictions are at all accurate, I would think that we’re going to need a lot more help to sustain such high growth. We have to remember that the brand moat is being built on quality - not quantity. I know from experience, it can be damn near impossible to find the right person to fill ONE position for a job. It might be interesting to know how Cognizant plans to find the additional long-term help its going to need as well as how to macro/micro manage the quality control of their teams.
CTSH 1-yr chart: