Summary
Cognizant used to be lenient with its margin profile until Elliot Management bought a $1.4 billion position in the stock.
Mr Paul Singer’s reputation is likely to have helped convince the management of the merits of margin expansion.
The stock price shot up by over 50% and before anyone knew Elliot had exited the stock.
Post Elliot, the pent-up investment demand of the last few quarters could lead to short terms excesses.
Thus, it would be important for Cognizant to stay the course on the margin front (albeit with less punishing rigor) to create overall value for the shareholders.
Elliot's November 2016 letter to Cognizant (CTSH) pulled the proverbial rug under the management's feet. Elliot wanted one of the world's largest IT services companies (F2018E revenue of $16.2 billion) to become more profitable, dumping CTSH's age-old policy of maintaining margins below 20%. The activist hedge fund's reputation preceded it and the CTSH management ceded. Elliot made money and left. CTSH is now at a point from where it can deliver 20%+ returns to shareholders, without compromising on its core philosophy.
Before Elliot
CTSH's defining feature was its long-standing philosophy of keeping operating margins low to invest in business growth. The company would invest anything in excess of 20% non-GAAP operating margin towards business growth. This was in stark contrast to the labor cost arbitrage-driven, margin crazed IT services industry.
