Cognizant brings down Infosys and TCS with fears of outsourcing slowdown

Profile picture for user slauchlan By Stuart Lauchlan August 6, 2014
Summary:
Cognizant turns in disappointing numbers and lowered guidance for 2014; Infosys and TCS pay the price as investors get jittery.

Cognizant CEO
Francisco D'Souza

Outsourcing giant Cognizant is disappointed with its performance, despite still being on track for its first $10 billion run rate year and the promise of its biggest deal to date.

What was interesting - and a little alarming - was the knock-on impact of the Cognizant numbers on the likes of Infosys and TCS, both of which saw their stock prices tumble as investors took fright at the prospect of a general outsourcing slowdown. It doesn’t take much to start a scare.

A sense of perspective is needed here. What the outsourcer has done is lower its full year growth guidance from 16.5% to a still very healthy 14%. That’s on the back of second quarter revenues of $2.52 billion, up 17% year-on-year.

The problem is that while all that’s been impressive enough, the firm expects to see growth stalling in the second half of the year, a result of what CEO Francisco D'Souza calls:

...weaknesses in certain clients and longer-than-expected sale cycles for certain large integrated deals.

While these deals represent a strong source of revenue for Cognizant, certain deals took longer than expected to close, leading to delays in revenue ramp-up.

While we believe that our client relationships remain sound, we will not generate as much revenue in 2014 from some of these clients as we had previously expected.

But he’s quick to put his comments into context:

We're talking about a small handful of clients, some of our larger clients. In terms of the spend coming back, look, I think our relationships at across-the-board remain very, very healthy. But given where we are in the year, the dynamics of our business are such that if you don't start projects and ramp up in the early part of the first half of the year, then it's hard to make it up on the back end.

But as we go into next year, look, I think we are positioned well with our client base, depending on where budgets come out and so on and so forth, those dynamics. I think we're well positioned to capture our fair share or an unfair share of what our clients are going to be spending and these same clients in the longer term.

It’s also not as though this has come as a huge surprise:

As our clients face [a] dual mandate, which is very, very real, of how do I run my operations better in order to fund the investments that I need in order to run different, this trend towards larger integrated deals is something that we're seeing more and more of.

What's happened is, sometimes, we're seeing clients reassessing priorities, shifting dollars from, say, run better to run different kinds of initiatives. And other times, it's just been just straight delays, frankly, where projects get pushed out. When that happens, just given the calendarization and the timing of things during the year, it becomes difficult to, essentially, to catch up in the year.

Customers are buying differently, argues D'Souza:

Clients across the industries that we serve, we've been talking about this for some time, are under continued pressure to drive ever-greater levels of productivity, efficiency, effectiveness. That's what we call the run better part of the dual mandate. So creating these large integrated deals is just a natural outcome of that.

In parallel with that, since we recognized this trend several years ago, we've been building out the core individual service lines that are required to service these large integrated deals. And largely, those are the traditional Cognizant application development and application maintenance service line, the IT Infrastructure service line and the BPS service line, and all of that wrapped with a consulting layer that Cognizant Business Consulting provides. So we feel like we're well positioned. Our capabilities, the ones that we've invested in over the last few years, really enable us to play in these large integrated deals.

Healthy prospect

One such outsourcing deal is set to be the largest in Cognizant’s history, a $2.7 billion, 7-year deal from HealthNet, a top 10 managed care organization in the U.S. A letter of intent has been signed with the expectation of finalizing the contract by the end of the third quarter.

Cognizant will provide end-to-end business services, including processing membership and claims as well as providing transformational IT and the underlying infrastructure services. Included within this deal is access to certain intellectual property related to the platform used to run the operation of a health care payer organization.

D’Souza says:

This engagement builds on our long-standing relationship with HealthNet for close to 10 years. Judging by our pipeline, we are seeing increased opportunity in these types of engagements and anticipate this to be a long-term trend. Winning and delivering these deals requires a broad range of integrated capabilities, in which we have been investing over many years: a strong consulting front end, solid client raising skills, deep domain knowledge and at-scale capabilities in technology and operations. And behind deals like these lies a deep sense of trust that our clients place in us, trust that comes from multiyear client relationships and deep levels of engagement within our clients' organizations.

healthnet
Of course, HealthNet’s status as an existing customer could also be seen as ironically representative of what Jennifer Hamel, analyst with Technology Business Research, refers to as over-dependence on existing client accounts:

The key challenge for Cognizant will be broadening its client base to decrease exposure to budget shifts in individual accounts.

But Hamel sees good signs:

Cognizant continues to perform well above the industry average low-single-digit growth with its combination of low-cost outsourcing and consulting-led digital transformation solutions that reduce costs and improve efficiency for clients’ IT environments.

TBR believes the company is moving in the right direction by hiring and acquiring experienced employees and building IP-based solutions to differentiate from its low-cost peers and compete directly with IBM and Accenture for outcomes-focused engagements.

My take

I can think of a few outsourcing firms that would be happy to be turning in 14% year-on-year growth.

This is a blip, not a long term trend for Cognizant. Keep calm, carry on.