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
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
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
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
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
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