Cognizant Shareholder Kerrisdale Applauds Elliott Management Activist Offensive

New York hedge fund Kerrisdale Capital Management, which owns $12.4 million in shares of Cognizant, Monday applauded the Elliott Management activist offensive against the $13.5 billion provider behemoth.

Following the release of a 16-page letter from Elliott Management pressing for changes aimed at driving up shares at Cognizant by 50 to 69 percent over the next year, Kerrisdale issued a tweet reading: "Excellent letter by Elliott on $CTSH (Cognizant), we own and agree. Improved margins, capital allocation -> multiple re-rating."

Excellent letter by Elliott on (), we own and agree. Improved margins, capital allocation -> multiple re-rating

In an interview with CRN, Kerrisdale Capital Management founder and Chief Investment Officer Sahm Adrangi said he was heartened by the Elliott call for changes at Cognizant.

"We think it is worth a lot more," said Adrangi of Cognizant shares, which closed up $3.70 (7 percent) on Monday to $56.95 after the release of the Elliott Management letter. "As a shareholder, it's great to see Elliott in there. Elliott has really carved out a niche for itself as a tier one premier hedge fund. I can't think of another shareholder we would rather have holding the stock and pressing for change other than Elliott. The investment thesis and idea really jibes with us."

As of the latest 13S filing, Kerrisdale Capital Management, which manages a $200 million portfolio, owns 217,228 shares of Cognizant. The shares represent the sixth largest holding for Kerrisdale which has been a Cognizant shareholder since mid-2014.

Adrangi said the Elliott Management activist bid represents a major move to drive significant changes at Cognizant. "We didn't find anything in that (Elliott Management) letter that we disagreed with," he said. "They made some very compelling points. Hopefully, they will bring this investment thesis to a broader audience that has not looked at Cognizant before. Hopefully, management adopts some of the ideas and concepts that Elliott puts forth in this letter. I am sure Elliott will do an excellent job communicating with management (at Cognizant)."

Among the changes demanded by Elliott: a shakeup of the Cognizant board of directors, a $2.5 billion stock buyback and a detailed plan aimed at driving a 23 percent adjusted operating margin for Cognizant in fiscal year 2018 compared with the 19.7 percent Cognizant achieved in fiscal year 2015.

[Related: 10 Things You Need To Know About Elliott Management's Activist Bid Against Cognizant]

Adrangi pointed out that the $1.4 billion four percent stake Elliott Management holds in Cognizant makes Elliott one of Cognizant's largest shareholders.
"This is a massive position that Elliott has taken," he said. "It's huge. When you look at Elliott's 13S their next largest position is less than a $1 billion stake. This is pretty big deal for Elliott. That is one of the things that excites us."

The activist offensive, in fact, is spearheaded by Elliott Management senior portfolio manager Jesse Cohn, who has successfully brought high-profile activist actions against a wide range of technology companies including Citrix Systems, Riverbed Technologies and BMC Software.

Most recently Cohn acquired a stake in identity-theft protection company LifeLock which was recently acquired by Symantec.

"Over the last five years, Cognizant has underperformed its core IT services peers by 83 percent despite growing revenue at a 22 percent CAGR ( compound annual growth rate) versus the peer average growth of a 16 percent CAGR over the most recent fiscal quarters," wrote Cohn in a letter to the Cognizant board of directors.

The Elliott Management Value Enhancement Plan is not a "cut and paste" activist prescription, said Adrangi. "They have highlighted issues and suggestions that are very specific to Cognizant," he said.

Adrangi echoed the Elliott Management calls for Cognizant to move beyond a strategy that maintains target margins at a level established nearly 20 years ago.
In his letter to management, Cohn said Cognizant "continues to practice and swear by a strategy that was developed nearly two decades ago, when revenues were over 200 times smaller, to keep operating margins in the 19 percent –20 percent range."

"Cognizant is a business that is 50 times larger than it was 15 years ago," said Adrangi. "The business is lot different today than it was back in 2003 when they had that same operating margin target. It just doesn't really make any sense."

Adrangi decried the Cognizant "self-imposed" 19-20 percent margin range target. "You can invest in M&A," he said. "You can invest in your own shares and buy back shares. There are a lot of things you can do with your excess cash flow. Why are you sticking with some arbitrary 20 percent number. The reason that is important for investors is because Cognizant is one of the leading players in IT outsourcing."

Cognizant's peers are trading at a much higher multiple than its industry peers, said Adrangi. In fact, Cognizant's operating margin of 18 percent is the lowest of all of the India-based IT services provider peers in an Elliott Management comparison including Tata, at 26.6 percent; Infosys, at 25.4 percent; HCL, at 20.3 percent; and Wipro, at 18.5 percent.

While all of Cognizant’s peers are focused on achieving higher levels of profitability longer term, Cognizant remains wedded to the same 19 to 20 percent range it has maintained for 20 years, said Cohn.

Adrangi said he sees further upside to the Cognizant shares with Elliott pressing for changes. Elliott, he pointed out, is on a "hot streak" with repeated successful efforts to drive shareholder value.