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Case Code: FINC139
Case Length: 11 Pages 
Period: 2000-2018   
Pub Date: 2018
Teaching Note: Available
Organization : Cognizant Technologies Solutions
Industry : Information Technology
Countries : India
Themes: Share buyback/Repurchase
Case Studies  
Business Strategy
Human Resource Management
IT and Systems
Leadership & Entrepreneurship

Cognizant-Share Buyback

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One of Jesse’s key observations was the benefits accrued by the shareholders of CTS in comparison to those of peers in the industry. An analysis of relative total shareholders’ return on CTS stock was negative between 2011 and 2016, in comparison with standard benchmarks like S&P500 Index and the NASDAQ Composite index and against a set of industry specific benchmarks like 10-K peers , Proxy Peer Groups , and Core IT Services Peers..

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Jesse and his team went deeper into studying the fundamentals of CTS. In spite of a strong growth in terms of revenues, the operating performance of CTS looked relatively stagnant. The operating margins of CTS since it went public in the year 1999 were between 19% and 20% . In addition to this, CTS did not follow a specific capital allocation policy to reimburse shareholders and did not provide a value to the investments..
To further underscore the performance of CTS, Jesse’s team found CTS was operating at what could be considered as a profitability discount compared to its direct peers. The first was weighed in terms of magnitude. In comparison with its closest peers like TCS and Infosys Limited (Infosys), CTS’s operating margins were less than ~7% to ~8%. The second basis of comparison was the company following a policy of working between operating margins of 19% and 20% . It was also observed that CTS maintained the target margins at less than 1000 basis points compared to its direct peers.
At CTS, in proportion to the increase in revenues, the operating margins had decreased over the years since 1999. From US$ 190 million in 1999, the revenue increased to US$ 12.5 billion in 2015. Still, the operating margins remained within 20%. Jesse’s team observed that the operating margins went on decreasing over the last several years..
Compared to its peers, CTS took a different view to capital allocation. Apart from going in for a few repurchases of shares to avoid dilution of the shareholding pattern, CTS did not offer any dividends to its shareholders. This was the situation despite CTS having earned revenue of US$ 13.5 billion and having US$ 2 billion of cash flows average per year, US$ 4 billion of net cash, and the opportunity to achieve a meaningful expansion of its business.
Jesse’s advice was to improve operational efficiency and return on capital. He wanted CTS to adopt suitable policies that would be helpful in improving the operational efficiency of the firm by 3% by the year 2018 . Adjustments could be made to maintain the operating margins at ~21% of the sales during the year 2018, as against the existing 18%. This was still discounted by 4%-5% as against its peers . Another significant focus was on utilizing the net cash to offer a repurchase program of a value of US$ 2.5 billion in early 2017, and offer a dividend of 1.5%.
After two months of consideration, CTS finally responded positively to the letter sent by Jesse. It reached an agreement with Elliot Group. As a first move, CTS refreshed the management board by inducting three new independent directors. It also accepted the suggestion of share buyback and dividend payment. CTS agreed to initiate the buyback process in the first quarter of fiscal year 2017 for US$ 1.5 billion and in the second quarter for a value of US$1.2 billion, which would continue for the financial year 2018.
Jesse’s projection of an increase in the market price of CTS stock to US$ 80–US$ 90 by the end of 2017 was considered too optimistic by market participants. Considering the steps taken by CTS on the suggestions given by Jesse’s team, it was predicted that the market price of the share could increase to around US$ 70. In spite of an increase in the market price of the share, an improvement in the operating margin by even 250 points by the end of year 2019 appeared to be more challenging.
There was news about CTS planning to reduce costs by cutting down on manpower and by focusing on automation. The other way was to reduce the variable pay component of the existing employees. The variable pay was normally paid at 150%-200% of the actual pay-out. The company planned to reduce the variable pay to 95% of the pay-out. The application of an intelligent and robotic process would not only eliminate expendable employees, but would also help to focus on utilizing highly skilled employees to work on higher-value projects.
As announced, CTS initiated the first stage of its share buyback process in March 2017. It associated with Barclays Bank PLC, Citibank N.A., and UBS AG, London Branch to start the process of Accelerated Share Repurchase (ASR) for a value of US$ 1.5 billion with a target of buying back 21.5 million shares. This process was funded by cash on hand and from its existing credit facilities as on March 14, 2017 .
Exhibit I:Relative Total Shareholder Return Figures
Exhibit II: Stock Performance of CTS stock against the Competitors and Market Indices
Exhibit III: Margins Comparison between CTS and its Direct Peers
Exhibit IV: Relative Revenue Growth Rates
Exhibit V: Return on Capital CTS Vs. Accenture