Wall Street Investment Firm: Elliott Management Hits The 'Bullseye' With Cognizant Demands

Investment management firm William Blair & Co. cheered Elliott Management Monday after the activist hedge fund investor released a letter to Cognizant’s management and board of directors urging them to make changes to the company aimed at driving up the value of the solution provider.

In a research note titled "Bull's-Eye – Elliott's Message to Management Should Resonate Well With Investors," William Blair analyst Anil Doradla said Elliot Management’s vision for the company is in line with demands Cognizant investors have been making for stronger stock performance over the last few years.

"We believe Elliott's concerns are consistent with ongoing demands from investors for stronger capital returns in the face of a changing IT services industry," Doradla said in the research note.

[Related: Activist Investor Elliott Management To Cognizant: It's Time To Shake Up Board, Buy Back $2.5B Shares ]

Concerns that Cognizant's management team was not address investors' calls for stronger returns was a core reason that William Blair downgraded its rating of Cognizant stock from "Outperform" to "Market Perform" last week, Doradla said, adding that management team "continued to be inflexible."

The letter from Elliott, which was released Monday morning, said Cognizant is the only company in its peer group that operates on the same margin strategy it did 20 years ago, noting that the company’s operating margins, inefficiency and lack of a capital return program have driven down the company’s value, leaving Cognizant’s stock price performance to become a "story of deep underperformance across all relevant bench marks, including all its closets peers over all time periods during the last five years."

"Cognizant continues to practice and swear by a [profitability and efficiency] strategy that was developed nearly two decades ago,’ Elliot Senior Portfolio Manager Jesse Cohn said in the letter.

However, Cohn also wrote that Cognizant – No. 7 on the 2016 CRN Solution Provider 500 - is one of the world’s most successful IT firms, adding that he believes there is significant upside to the stock from current levels (50% to 69% from Friday’s closing price of $53.25.)

In his letter, Cohn laid out a "Value-Enhancement Plan," that he believes will create more value for the company.

In the plan, he urges Cognizant management to expand operating margins, initiate a dividend, commence a $2.5 billion accelerated share repurchase program and commit to return 75 percent of free cash flow to shareholders.

The letter also disclosed that Elliott holds a $1.4 billion investment in Cognizant, which accounts for over 4 percent of Cognizant shares making Elliott one of Cognizant’s largest four shareholders.

During trading hours Monday, Cognizant’s stock about 9 percent, to $58, before leveling off to about $57 by the end of the day.

However, Doradla's statement said the company still believes there is still a lot of work to be done by Cognizant to achieve what Elliott has laid out.

"The plan would require a significant change to the company's operating structure, which has produced diminishing returns on invested capital over the last several years despite continued focus on investments," Doradla said. William Blair will be maintaining its current, Market Perform" rating for Cognizant, Doradla said, noting investors should expect volatility in the stock as investors anticipate more definition around Cognizant’s long-term strategy.