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Analysis of activist proposal for competitively efficient company's "capital distribution program"


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Source: TheStreet, November 28, 2016 article

Elliott Urges Cognizant Debt Hike for M&A and Share Buybacks

■ Activist Paul Singer urged Cognizant to take on more leverage to help fund research and acquisitions and to set up a $2.5 billion share buyback program.


By Ronald Orol  |  Nov 28, 2016 4:21 PM EST 


IT services company Cognizant Technology Solutions Corp. ((CTSH)) shares jumped 10% early Monday after billionaire Paul Singer and his activist investment fund Elliott Management launched a campaign urging the company to take on more leverage to help fund research and M&A at the same time that it initiated a $2.5 billion share buyback program.

"Despite growing into a scale market leader with stable and significant cash flows, Cognizant has remained unwilling to establish a capital return program," said Elliott portfolio manager Jesse Cohn in a 16-page-letter.

The activist fund pointed out that Cognizant has $4 billion in net cash, including $1.1 billion in onshore cash following a recent repatriation and "virtually no debt." Cognizant, which has a $36 billion market capitalization, had $896 million in debt as of Sept. 30, according to its most recent quarterly report.

The activist fund said that Cognizant is trading at its lowest valuation since the financial crisis, which makes it a good candidate for buying back shares to boost its undervalued share price. It also is urging Cognizant to move substantially beyond its existing buyback approach, which only "repurchases shares to offset dilution." The fund is urging Cognizant to complete a $2.5 billion share repurchase program in the first half of fiscal year 2017, funded partly by cash on its books and new debt. In addition, Elliott wants Cognizant to set up a dividend program in part to help attract a new class of investors.

Cognizant trades at $57.69 a share, up about 9% on the Elliott campaign-- and Cohn suggests the IT services company can achieve a value of between $80 and $90 a share by the end of 2017.

In addition, Elliott urged Cognizant to hike its unusually low operating leverage to help it make "sound investments" in research and development and M&A. The insurgent funds compared Cognizant to Accenture PLC ( (ACN) ), which has a large IT services business, noting that the New Jersey-based company has only made eight acquisitions since 2014 while the Chicago-based professional services rival has bought 45 companies in the same timeframe.

A person familiar with the situation noted that Cognizant could make a number of bolt-on smaller acquisitions in the IT services space to help drive profitability.

Elliott also urged Cognizant to make changes to its delivery process, its sales and marketing program and make cuts to its human resources department and finance unit. However, people familiar with the fund said Cognizant should hike its operating leverage, in part, to invest in hiring more employees focused on R&D.

It is very possible that Elliott could launch a contest if Cognizant doesn't implement some or all of their recommendations. The New York activist fund has launched more than 96 campaigns at 92 companies since 1994, according to FactSet. It has also undertaken 13 proxy fights and threatened director-election contests at four companies in efforts to drive M&A and other moves.

In fact, Elliott hinted at a possible contest, arguing that Cognizant's price "underperformance" suggests that "directors with new experiences, skills and perspectives" would be welcome. The insurgent fund could take advantage of some Cognizant governance red flags if it were to launch a director election contest. In particular, a number of the IT service company's directors have served on the company's board for a long time, raising questions about whether they may be too cozy with the management team. According to relationship mapping service company BoardEx, a service of TheStreet, four directors have served on Cognizant's 10-person board for more than 12 years, including chairman John Klein, who has served for almost 19 years.

If Elliott wants to launch a contest, it would need to submit dissident director candidates between Feb. 15 and March 17 to meet Cognizant's director nomination rules for its 2017 annual meeting, likely to take place in June. The person familiar with the situation noted that Elliott is looking for Cognizant to produce its response to the fund's concerns by February, when its next quarterly report comes out.

Elliott accumulated a 4% stake in common equity and share equivalents, for about $1.4 billion, making the position one of the fund's largest initial equity investments. Other activist funds, including Kerrisdale Advisors LLC, Clinton Group Inc. and Carlson Capital LP, own small stakes in Cognizant and would likely back a contest if one were launched. Kerrisdale Capital tweeted on Monday that it agreed with the Elliott plan, adding that Cohn's letter was ""excellent."

Cognizant directors are elected annually, which means Elliott could launch a contest to take over the board if it so wished even though the fund has almost never launched a change-of-control contest in its past.

In hopes to generate shareholder backing for its thesis, Elliott noted that it worked with a consulting firm, IT purchasers and senior information technology services executives to develop its research plan.


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