Cognizant Technology Solutions Corp. (CTSH) · 3/11/2019 · Cognizant Technology Solutions Corp. (CTSH) is a leading custom information technology consulting, technology services,

Initiation of Coverage March 11, 2019

Kayzad Jokhi | Lead Analyst [email protected] | (610) 314-9504

Oliver Tenlen | Associate Analyst [email protected] | (801) 244-1387

INVESTMENT THESIS

• CTSH is trading at a 12.0% discount to its median two-year LTM P/E of 20.46x. Through our discounted cash flow analysis, we see shares as having ~17% upside with our price target of $82.10/share.

• CTSH has become undervalued as a result of overblown fears from investors in regard to a recent slowdown in revenue growth from top customers within the company’s financial services end-market. However, these issues are more indicative of these companies’ transition towards to digital spending, and not pointing to systemic issues within the banking client base as a whole.

• Looking forward, CTSH should be able to reap the benefits of the company’s repositioning towards its digital products and services. CTSH’s digital business lines are expected to deliver a 20-25% CAGR, boosting expected top-line growth over the medium-term to a 7-11% CAGR.

• Additionally, as the company moves past the short-term struggles that have blemished the past few quarters’ results, CTSH should be able to turn these headwinds into tailwinds in the Financial Services and Healthcare end-markets.

• CTSH’s strategy and culture of innovation has positioned the company very favorably in comparison to competitors. CTSH continually invests in strategic M&A, as the company pushes itself to continually improve its offerings and innovate to improve the customer experience.

COMPANY OVERVIEW

Cognizant Technology Solutions Corp. (CTSH) is a leading custom information technology consulting, technology services, and outsourcing services company. The company aids the shift of business processes to digital operations through intelligent systems, automation, cloud technologies, and cyber security tools. CTSH also offers more traditional IT services such as application maintenance, software development, and re-engineering services for legacy systems, among others. Revenue is derived from the following geographies: North America (76.2%), Europe (17.6%), and RoW (6.2%). Domiciled in Teaneck, New Jersey, CTSH is set to report 1Q’19 earnings on May 6th, 2019.

Cognizant Technology Solutions Corp. Exchange: NASDAQ | Ticker: CTSH | Target Price: $82.10

Key Statistics (US$ in M, except per share data) Price (08-Mar) $71.15 52-Week Low $59.47

Exp. Return ~17% 52-Week High $85.10

Shares O/S 575.1 Div. Yield 1.12%

Market Cap $40,918 Ent. Value $37,152

One-Year Price Graph

Earnings (Adj.) / Revenue Surprise History Quarters EPS Revenue Δ Price 1Q’18 0.47% 0.26% (5.25%) 2Q’18 8.38% (0.50%) (6.37%) 3Q’18 4.94% (0.14%) (3.90%) 4Q’18 5.61% 0.36% 4.62%

Earnings Projections (Adj.)

Q1 Q2 Q3 Q4 FY 2016A $0.75 $0.76 $0.76 $0.76 $3.03 2017A 0.88 0.88 0.91 1.10 3.77 2018A 0.93 0.96 0.88 1.18 3.95 2019E 1.04 1.11 1.14 1.16 4.45

Source: Bloomberg, FactSet, CapIQ The William C. Dunkelberg Owl Fund does and seeks to do business with companies covered in its research reports. Thus, investors should be aware that the fund may have a conflict of interest that could affect the objectivity of this report. All prices are current as of the end of previous trading session from date on which report was issued.

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Spring 2019

Technology: IT Services Page 2

CTSH BUSINESS OVERVIEW

Cognizant is a leading professional services company, transforming operating and technology models to excel in the digital era. Through an industry-based, consultative approach, clients envisage, build, and run more efficient and innovative businesses. The company’s services include Digital Business, Digital Operations, and Digital Systems and Technology, all underlined by the Cognizant Consulting, Global Technology Office, and Cognizant Accelerator units. Its services are offered to the following end-markets:

End Markets

Financial Services (36.2% of FY’18 Revenue) – includes banking, capital markets, and insurance companies. Demand in this segment is driven by clients’ need for cost optimization under profitability pressures, need to be compliant under significant regulatory requirements and adaptability to regulatory change, and need to adopt and integrate digital technologies. Key technologies demanded in this segment include customer experience enhancement, process automation, analytics and AI in areas such as digital lending and payments.

Healthcare (28.9% of FY’18 Revenue) – is comprised of healthcare providers, payers, and life sciences companies. Demand in this segment is driven by emerging industry trends, such as increased compliance, integrated health management, claims investigations services. Along with typical healthcare offerings, Cognizant offers adoption and integration of AI, personalized care plans, and predictive analytics to improve patient outcomes.

Products and Resources (21.2% of FY’18 Revenue) – consists of manufacturers, retailers, travel and hospitality companies, logistics, and energy and utilities providers. Demand in this segment is driven by clients’ focus on improving operational efficiency, integration of mobile platforms to support sales, and adoption and integration of supply chain and customer experience technologies.

Communications, Media and Technology (13.6% of FY’18 Revenue) – encompasses information, media and entertainment, communications, and technology companies. Demand in this segment is driven by clients’ needs to manage digital content, create differentiated user experiences, and adopt and integrate cloud and interactive, connected products.

Service Units

Cognizant Digital Business - The Digital Business reinvents clients’ existing business models, innovating products, services, and experiences, Areas of focus in the business unit are digital strategy, AI and analytics, connected products, interactive user experiences, and building custom applications. Cognizant Digital Operations - The Digital Operations practice modernizes business operations by re-engineering and managing essential processes, lowering operating costs, improving employee and customer performance, and accelerating top-line growth. Cognizant Digital Systems and Technology - The Digital Systems and Technology unit reshapes technology models, simplifying, modernizing, and securing systems. Areas of focus include systems integration, infrastructure (cloud), security, and application development, testing, and maintenance.

Cognizant Consulting, Global Technology Office, and Cognizant Accelerator - Supporting Cognizant’s three service units, the consulting team provides global business, process, operations, and technology consulting services. Its SME work closely with practice areas to create industry-focused frameworks, platforms, and solutions. The Global Technology Office and Cognizant Accelerator focus on utilizing new technologies to develop and innovate offerings for clients’ emerging needs and support the company’s business segments and practice areas.

36% 29%

21%14%

Segment Breakdown

Financial Serivces

Healthcare

Products andResources

Communications,Media andTechnology

Spring 2019


INDUSTRY OVERVIEW

The IT Consulting Market:

The IT consulting industry is comprised of companies that help businesses design and implement information technology (IT) systems and infrastructure. Over the past five years, shifting technological trends toward cloud computing and data analytics have caused larger operators to acquire smaller companies and develop new products to stay relevant. Shifting technology trends have boosted demand for new services and encouraged companies to replace older, more-traditional technology. Additionally, strong corporate profit growth during most of the current period and constantly rising investment in computers and software have helped support the industry's growth. The continued shift to cloud computing and rising use of data analytics will heighten security concerns for businesses, precipitating increased demand for industry services. The following statistics were taken from a survey conducted by PricewaterhouseCoopers of 300 executives of various U.S. companies: • Nearly all of the 300 executives surveyed by PwC said they see data on customers and clients as “critical or

important” to getting an edge on competitors in the years ahead • 76% of those surveyed said their firms are aiming to extract value from the data they already have • Most firms see “tremendous upside opportunity in fully optimizing the data they already have” • The executives said cleaning up their data will lead to average cost savings of 33%, while boosting revenue by

an average of 31%.

What are the drivers of enterprise IT spending?

Private business sector spending accounts for ~75% of IT consulting revenues, with the largest client bases operating in the financial services, healthcare, manufacturing, and telecommunications sectors. Each end-market and company has significantly different use cases for IT consulting, so it is imperative that consulting firms tailor their offerings to the specific needs of its clients.

• Banking & Financial Services: Financial services companies are expected to be the largest consumers of IT services by revenue, estimated at 23.7% of FY’18 industry revenue. For this space, operations that require significant IT investments include fast and reliable network connections, cybersecurity, and advanced data processing capabilities. Since this industry does not allow for any significant economic moats, banks are utilizing investments in technology to separate themselves from the competition.

• Healthcare & Life Sciences: The healthcare sector presents a tremendous opportunity for IT consulting companies, as demand for in this space has significant growth prospects. Demand by healthcare companies will be driven by increased healthcare expenditures, rising regulatory compliance costs, and increased outsourcing of electronic medical records management to outside providers. More specifically with compliance, costs associated with the Affordable Care Act and state-level health insurance exchanges have accelerated demand for greater efficiency. Industry wide, rising health expenditures within the United States should maintain consistent growth in demand for network and system management, and IT support services.

• Manufacturing & Retail: Manufacturing and retail customers have invested significant amounts on IT spending in order to improve operational efficiency, which is key for margins in an increasingly competitive space. Specifically, this end-market invests dollars on point of sale systems, logistics, and inventory management systems. As of late, AMZN’s efforts in logistics have added increased pressure on competitors in this space to boost spending to increase logistical efficiencies in a supply chain that is becoming increasingly global.

• Communications, Media, & Technology: Technology has become a significant reason for the increased disruption within the telecommunications industry. For example, the rollout of 5G technologies will radically change the way media is consumed, as larger amounts of data can be moved at speeds never seen before in wireless.

Spring 2019


Consulting, Outsourcing, Offshoring, and In-House IT Support:

Enterprises have many options when considering how to employ IT in order to meet the operational needs of the firm. IT consulting relates to the practice of advising organizations on how to best deploy information technology in achieving their business objectives, which typically happens on-site. IT outsourcing refers to the subcontracting of some or all of the company’s IT operations to an external organization. IT offshoring, while similar to outsourcing, refers to moving IT work to a different, typically to take advantage of cost benefits. Lastly, companies could decide to make the full investment in an in-house IT team.

Why choose one option over another?

In comparison to the other three options, an in-house IT support team is very costly and difficult to scale with innovations and changes in technologies. For companies that require for only a few projects to be completed, it makes more sense to bring in a consultant that is an expert in the specific task and get paid for the time spent there. When a company hires an outside firm to consult, it is then not required to make the significant up-front costs for equipment or software necessary to complete a majority of IT tasks or projects. With IT offshoring, businesses are looking to move project work overseas to lower-cost regions in order to see significant cost benefits (see above). However, this strategy comes with potential risks such as communication issues and various geopolitical risk. Outsourcing, similarly, is used by companies to take advantage of specialized skill sets, labor flexibility, and cost efficiencies. However, potential downsides to outsourcing includes a misalignment of interests of clients and vendors.

Where are all the workers?

An industry-wide headwind to operations in IT services is the shortage of skilled labor in high-cost regions. As evidenced in the chart (see right), the demand for technology-oriented labor is significantly greater compared to that of the general labor force. This bottleneck can have an impact on the decision enterprises have to make regarding how IT projects will be completed. So how can companies circumvent this issue? IT offshoring can provide significant cost savings as a result of lower employee costs in emerging markets such as India. Brexit could accelerate this trend in offshore IT, as UK firms will have more difficulty finding qualified workers and are looking for ways to cut costs. This will benefit all IT services companies that provide managed cloud services such as Cognizant, Accenture, Capgemini, Tata Consultancy Services, and Infosys. This issue of a labor shortage exasperates the difficulties of establishing an in-house IT team. IT consulting and outsourcing firms offer the flexibility of labor and resources on-demand, custom-made to the business’ specific needs.

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Spring 2019


UNDERVALUATION & THESIS:

• CTSH is trading at a LTM P/E of 18.01x, an 8.1%, 12.0%, and 10.2% discount to its one, two, and three-year historical median P/E respectively.

• CTSH is trading at a discount to its historical P/E averages as a result of overblown fears regarding the company’s largest end-market, Financial Services. In the past few quarters, CTSH has noted weakness in the customer-specific IT spending of the Financial Service segment’s top five customers. Investors have feared the worst with this news, with worries that these issues are representative of much larger issues with the demand for IT services with all banks and financial institutions. However, in recent quarters, CTSH has seen an uptick in spending from two of the top five customers in this group. In fact, as seen with these two customers, it is very likely that this temporary slowdown in spending is the transition from legacy IT offerings to CTSH’s digital offerings. We side with management’s belief that this is merely customer-specific and not representative of larger trends in this end-market.

• Looking forward, CTSH’s realignment to focus the business on its digital offerings should help to reignite growth in its financial services end-market customers, while adding fuel to an already growing customer base in its other segments. CTSH has completely repositioned the business to focus on its digital solutions, evidenced by three of its four service units dedicated to its various digital products. In terms of CTSH’s mid-term revenue growth targets of 7-11%, digital offerings will help make this attainable with a projected CAGR of 20-25%. We also the value the importance that enterprises see in these technologies, which should help maintain rapid growth in this space.

• Lastly, we value CTSH’s more defensive qualities which helps it withstand the impact of a market-wide economic downturn. 75% of CTSH’s revenues come from the United States, which protects the company from outsized foreign exchange risk and economic instability in international markets. Additionally, the company’s client base is from the enterprise community and focused on relatively stable end-markets, banking/financial services and healthcare.

CTSH 2-Year Median LTM P/E

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Mar-17 Jun-17 Sep-17 Dec-17 Mar-18 Jun-18 Sep-18 Dec-18 Mar-19

Broader marketvolatility sent CTSH

and peers plummeting (CTSH down ~21.5%,

XLK down ~24%)

Missed on top, beat on bottom. CTSH

missed expectations for FS revenue

Beat on top and bottom line. Shares fell as CTSH lowered EPS guidance by $0.09 as a result of a new

interpretation of the tax law

Strong finish to FY'17, with a top and bottom beat. FY'18 guidance

raised. Dividend raised 33%.

Strong 4Q'18 results, with two of five top

banking clients returning to growth, coupled with

positive guidance

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Spring 2019


Mid-Term Growth Targets

CATALYSTS & DRIVERS:

Going Digital: Welcome to the Future

As of late, CTSH has undergone a significant repositioning of the company, with the new focus of the company centered on its digital offerings. These investments have been focused on bolstering the company’s strategy in the following six capabilities: Digital Engineering, Interactive, Industry & Platform Solutions, Intelligent Process Automation, Core Modernization, and Analytics & AI. In the company’s view, the operation of its traditional offerings, which includes tasks such as business intelligence and data warehousing, is critical to supporting growth in these new-age products and services.

Why Digital? An essential aspect for succeeding in the IT services space is to continually adapt and change to meet the needs of the customer base. In following with this thesis, CTSH has broken its operations into four service units, three of which are dedicated to its digital offerings: Digital Business, Digital Operations, and Digital Systems & Technology. Throughout CTSH’s numerous digital offerings, the objectives for the use of these products and services is actually rather simple: cost-savings, efficiency, and strategic positioning.

• Cognizant Digital Business: This service unit helps customers reshape their business models, using next-generation applications and services to help businesses grow at speed and scale. CTSH takes a holistic approach to the digital business unit, looking for innovations in products, services, and experiences.

• Cognizant Digital Operations: This unit focuses on helping customers rethink their operating models and modernize these crucially important business processes that can lower operating costs, improve employee and customer outcomes, and drive growth in the business. These solutions can greatly improve the process automation and efficiency of typical core front, middle, and back-office processes which includes finance and accounting, data management, procurement, and research & analytics.

• Cognizant Digital Systems & Technology: The Digital Systems & Technology unit focuses on the technology models that can be implemented to improve the applications and systems that allow the business to function. CTSH’s areas of focus in this space are system integration, infrastructure services (including cloud technologies), security, and application services. These application services include traditional development, testing, maintenance, and agile development of new software and applications.

Impact on CTSH

Within the scope of CTSH’s operational and financial performance, the transition to digital has done wonders for the future prospects of the company. For the company’s struggling banking clients, the recent slowdown in spending is seen as a transitional phase towards greater investments in digital products/services. As evidenced in the graphic (see above), digital revenues are expected to accelerate total revenue growth for the medium-term, with an expected 20-25% revenue CAGR. CTSH has the capabilities and expertise to aid the transition from legacy IT to its digital offerings and can capitalize on those currently a part of its clientele base. These new revenue opportunities should help aid growth for the short, medium, and long-term as it transitions legacy customers to future-focused products. CTSH benefits from the higher margins of these businesses, as customers are willing to pay a premium for these in-demand solutions. CTSH continues to make investments in these digital offerings through extensive training, re-skilling, and the geographic expansion of workforces within the United States and internationally. Digital offerings now make up over 30% of total revenue, which offers the company a long “runway” for continued growth for years to come.

Total Revenue CAGR: 7-11%

Organic Revenue

CAGR: 6-9%

Digital Revenue CAGR: 20-25%

Inorganic: +1-2%

Spring 2019


Renewed Strength in Financial Services & Healthcare End-Markets

A key aspect of CTSH’s undervaluation story is the weakness the company has seen in recent quarters from specific lines within its Financial Services and Healthcare end-markets. However, as the company overcomes these short-term challenges, investors should see renewed strength in the growth of these end-markets.

The Top Five Clients

Investors feared over the past year that a slowdown in spending in CTSH’s five largest banking clients were indicative of systemic issues with the entire customer base. However, the absence of short-term lingering issues will help investors “see the light” for banking’s return to steady growth. As evidenced in the 4Q’18 earnings release, this strategy is already in motion. CTSH saw two of these five clients return to growth in the most recent quarter. Additionally, CTSH is working to further diversify its banking client base to reduce its exposure to the spending trends of its larger clients. Diversification efforts have been led by significant growth in its European banking client base. CTSH has made significant investments in its platform and European delivery centers to better meet the needs of these customers.

Deal-Making & The Government Shutdown

CTSH’s healthcare clients, despite generating solid growth in past quarters, has caused concerns from investors in recent quarters with lower-than-expected growth. These concerns should be put to rest in the coming quarters as CTSH will benefit from not facing two primary headwinds: M&A causing a temporary spending pause and the adverse effect of the government shutdown on healthcare sub-contracting work.

• M&A Activity: Within healthcare, large-scale M&A activity has become commonplace. Many of these deals are of significant scale, requiring extensive restructuring and integration efforts. Recent deals in this space, which include CI-ESRX, CVS-AET, and HUM-KND, have caused a temporary slowdown in IT spending during the integration process. As these pressures subside, CTSH should be able to benefit from even greater consulting revenues from these companies. The goal of acquiring businesses in the insurer-PBM business model is to create cost-saving and efficiency opportunities. CTSH has numerous products and services that are custom-tailored to the needs of healthcare companies. CVS recently appointed Roshan Navagamuwa as the company’s CIO and placed him as the person in charge of integration work with AET. In a recent interview, Roshan pointed out cloud computing as an enabling factor in the integration process by helping the firm move quickly to take advantage of both existing and emerging software and services. Among other tools, Mr. Navagamuwa plans on implementing big data and analytics technologies to help the combined firm integrate and deliver care that will be easier to use. This is simply one of many examples of how CTSH can offer products and services to take advantage of this larger industry trend.

• Government Sub-Contracting Work: First, government sub-contracting refers to CTSH being hired to perform a specific task as part of an overall project and is compensated for services provided to the project by the originating general contractor. This most recent government shutdown, from December 22, 2018 until January 25, 2019, was the longest government shutdown in U.S. history. CTSH, which works with firms that are given work by the government, felt the burn of lost work as certain government agencies were forced to temporarily close doors. Looking forward, CTSH should benefit from the lack of this headwind to results after 1Q’19. The full benefit of this turnaround should be realized by 3Q’19.

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Spring 2019


ADDITIONAL COMMENTARY

The Cognizant Strategy: One Step Ahead Of The Curve

CTSH, in all aspects of its operational strategy, continues to make strides in separating itself from the competition. CTSH has developed three primary ways in which it has produced a differentiated offering from others in the consulting space.

• End-To-End Product Portfolio: CTSH offers products and services for virtually every enterprise lateral. The company’s offerings, from digital to traditional IT offerings, allows for it to address a broader market for its solutions. Very few players in this space can offer similar levels of diversity in its offerings to a broad base of end-markets.

• Geographic Exposure (See Appendix II): In FY’18, CTSH derived 76.2% of its revenues from North America, 17.6% from Europe, and 6.2% from the rest of the world. CTSH benefits from having a significant portion of its global workforce in India, as IT operating costs per employee is significantly lower than most countries, including the U.S., UK, and China. Additionally, a lack of exposure in more currently unstable economies such as China shields CTSH from potential volatility.

• End-Market Diversity: CTSH has a very balanced distribution of revenues from its various end-markets. Looking forward, continued strength from the Products & Resources and Communications, Media & Technology end-markets will help CTSH further diversify away from industry-specific cyclical spending trends it may face.

The Customer Is Always Right

CTSH’s customer-focused strategy permeates through every touch point in its operations. CTSH markets and sells its services through its direct salesforce, taking place in the United States and around the world. The sales process, depending on the client, can take between a few months and a full year. CTSH management has noted that it has identified 360 “strategic customers” in that they have the potential to reap an additional $5 million-$50 million or more in annual revenue from this group. CTSH benefits from having much of its business contracted in advance, some for a few years ahead. However, CTSH and its peers is facing headwinds in the form of contracts lasting for more short-term periods. While this does not guarantee revenue loss, CTSH have recently become more exposed to this industry-wide risk.

Adding Value Through Acquisitions (See Appendix III)

CTSH, in an effort to stay at the front-line of innovation in a rapidly evolving technological environment, has utilized its ample cash holdings for strategic M&A that is used to quickly add improvements to its current offerings. CTSH’s most impactful acquisition, and indicative of the impact these acquisitions can make, can be traced back to its September 2014 deal for privately held TriZetto Corp. for $2.7B in cash. CTSH made this deal in order to capitalize in a growing trend in healthcare it had identified nearly five years ago: the demand for IT solutions in order to keep up with the increasing costs associated with regulatory compliance. Years later, this investment in a solution that CTSH foresaw years in advance would be needed has paid off for the company. Along with its consulting arm, TriZetto’s healthcare products are now a key staple of the company’s solutions for healthcare customers. Looking forward, CTSH has a significant stockpile of dry powder for future M&A activity, with ~$4.5B in net cash and investments. 2019 is already off to an impactful year for M&A as CTSH agreed on March 5th to acquire Meritsoft, a Dublin-based specialist financial services software company. The company is best known for its Finbos platform, which is an automation solution for managing taxes, fees, commissions, and cash flow functions between financial institutions. We expect CTSH to continue in its efforts to continually innovate and improve its solutions for clients across all industries.

Spring 2019


PEER GROUP ANALYSIS

Accenture PLC (ACN): Accenture PLC, the world’s largest consulting firm, offers a portfolio of management consulting, technology, and business process outsourcing services. The company’s clients include governments and three-quarters of corporations in the Fortune Global 500, spanning across approximately 40 industries. Atos SE (AEXAY): Atos provides digital services including cyber security, data center, application, cloud solution, software, transformation, integrated systems, and automation. With a firm grip over the European IT services market, the company serves aerospace, automotive, banking, defense, insurance, media, transportation, energy and sports industries worldwide. Capgemini SE (CGEMY): Headquartered in Paris, France, Capgemini offers information technology services including mobile software solutions, business process management, outsourcing, cloud computing, finance, consulting, supply chain management, engineering, and other services. The main industries the company serves are aerospace, defense, automotive, health care, life science, telecom, media, and entertainment industries. DXC Technologies Co. (DXC): DXC Technologies, domiciled in Palo Alto, California, was formed and launched in April 2017 from the merger of Computer Sciences Corporation, Electronic Data Systems, and the Enterprise Services segment of Hewlett Packard Enterprise. The company provides information technology services including analytics, applications, business process, cloud and workload, consulting, and security services, and solutions. Infosys Technologies (INFY): Infosys Technologies is one of India’s leading technology service firms, mainly offering software development and engineering to corporations worldwide through its subsidiaries. Its US-based consulting arm provides IT and professional consulting services, with North America accounting for two-thirds of total revenue. The main industries served by Infosys Technologies are financial services, insurance, manufacturing, telecom, retail, and consumer goods.

Company Market Statistics Growth Analysis Margin Analysis Valuation AnalysisEnterprise Value /

Market Enterprise Sales EPS EBITDA Margin Profit Margin EBITDA Sales Price / EarningsTicker Cap Value LTM 2019E LTM 2019E LTM 2019E LTM 2019E LTM 2019E LTM 2019E LTM 2019E

Cognizant Technology Solutions Corp. CTSH $41,482 $37,716 8.9% 7.6% 5.4% 13.0% 21.2% 21.7% 13.0% 14.8% 10.0x 9.2x 2.2x 2.0x 18.1x 16.1x

Accenture Plc ACN 104,827 100,861 12.0% 3.2% 13.9% 7.3% 16.5% 16.5% 9.8% 9.8% 14.4x 13.9x 2.3x 2.2x 23.7x 22.0xDXC Technolgies DXC 18,047 23,466 (5.2)% (15.3)% 3.7% 25.9% 17.7% 17.7% 7.1% 7.1% 6.1x 4.6x 1.1x 1.1x 9.3x 7.6xInfosys Technolgies INFY 45,672 41,925 3.0% 17.3% 1.0% 3.4% 26.4% 25.6% 19.0% 19.2% 14.4x 14.1x 3.8x 3.6x 21.5x 19.5xAtos SE ATO 9,111 14,010 (0.0)% 11.8% 1.0% 24.4% 13.5% 13.6% 6.3% 7.1% 10.0x 6.9x 1.1x 1.0x 14.4x 9.6xCapgemini CAP 17,917 19,084 4.3% 6.8% (3.3)% 24.4% 13.1% 14.5% 5.5% 7.8% 12.3x 9.0x 1.4x 1.4x 24.5x 14.2x

High $104,827 $100,861 12.0% 17.3% 13.9% 25.9% 26.4% 25.6% 19.0% 19.2% 14.4x 14.1x 3.8x 3.6x 24.5x 22.0xMean 56,182 55,417 2.8% 4.8% 3.3% 17.1% 20.2% 19.9% 11.9% 12.0% 11.4 9.7x 2.4x 2.3x 18.7x 14.6xMedian 45,672 41,925 3.0% 3.2% 3.7% 7.3% 17.7% 17.7% 9.8% 9.8% 14.4 13.9x 2.3x 2.2x 21.5x 19.5xLow 18,047 23,466 (5.2)% (15.3)% 1.0% 3.4% 16.5% 16.5% 7.1% 7.1% 6.1 4.6x 1.1x 1.1x 9.3x 7.6x

Company General Statistics Returns Analysis 2018A Leverage Analysis 2018A Coverage Analysis Liquidity Profile Credit ProfileTotal Debt /

Dividend EBITDA / (EBITDA EBIT / Quick CurrentTicker Tax Rate Beta Yield ROIC ROE ROA Cap EBITDA Equity Int. Exp. -Cpx)/Int. Int. Exp. Ratio Ratio Moody's S&P

Cognizant Technology Solutions Corpo CTSH 20.6% 0.94 1.1% 17.8% 19.0% 13.5% 0.0x 0.2x 6.5x 103.0x 91.0x 86.6x 2.80 3.12 - -

Accenture Plc ACN 19.8% 1.08 1.8% 48.1% 38.7% 17.0% 0.0x 0.0x 0.2x 408.6x 391.3x 361.6x 1.22 1.33 A1 A+DXC Technolgies DXC 0.6% 1.08 1.1% 5.5% 12.9% 4.9% 0.4x 2.0x 66.6x 11.0x 9.9x 4.7x 0.89 1.00 Baa2 BBBInfosys Technolgies INFY 29.2% 0.90 2.3% 18.6% 22.8% 18.7% 31.0x 2.2x 44.9x 25.5x 21.6x 20.5x 2.58 3.29 A3 A-Atos SE ATO 6.3% 2.38 2.4% 6.0% 11.7% 3.6% 0.7x 3.9x 66.9x 43.6x 28.7x 26.1x 0.77 1.17 - BBB+Capgemini CAP 38.2% 1.51 2.0% 7.9% 10.1% 4.5% 0.2x 2.2x 44.9x 25.5x 21.6x 20.5x 1.01 1.45 - BBB

High 29.2% 1.08 2.3% 48.1% 38.7% 18.7% 31.0x 2.2x 66.6x 408.6x 391.3x 361.6x 2.58 3.29Mean 16.5% 1.02 1.7% 24.0% 24.8% 13.5% 10.5x 1.4x 37.2x 148.3x 141.0x 128.9x 1.56 1.87Median 19.8% 1.08 1.8% 18.6% 22.8% 17.0% 0.4x 2.0x 44.9x 25.5x 21.6x 20.5x 1.22 1.33Low 0.6% 0.90 1.1% 5.5% 12.9% 4.9% 0.0x 0.0x 0.2x 11.0x 9.9x 4.7x 0.89 1.00

Spring 2019


RISKS TO INVESTMENT THESIS

Employee Attrition

In the IT services space, as mentioned earlier, the demand in the labor market for the services of skilled technology personnel constantly weighs on the supply available in this market. The unemployment for technology professions consistently is lower than the general U.S. unemployment rate. Additionally, CTSH operates in a space where attrition rates hover in the ~20% range. To combat this headwind, CTSH has added an emphasis on better managing overseas utilization. CTSH continues to make investments in its employees to control this rate.

Continued Weakness in Financial Services

A key aspect of the undervaluation story for CTSH is the recent weakness in the company’s Financial Services end-markets. Factors that accelerate this risk include increased hawkishness of budgets and an earlier-than-expected economic slowdown/instability. While we believe there are multiple factors that will drive growth and confidence from investors in this end-market’s potential, we acknowledge the potential for a prolonged slowdown in IT spend by the large banking customers.

Increased Competition

As a consequence of CTSH wide array of competition, the company faces competition in every line of business it operates in. An essential aspect of earning business from clients is being able to continuously offer better services and products. Competitors among many of the markets CTSH operates in includes Accenture, Infosys, Tata, and DXC. If competition and/or pricing pressures was to intensify, CTSH would face significant growth and margin pressures.

Missed Margin Expectations

CTSH has spelled out how it plans to achieve its industry-leading FY’19 non-GAAP margin target of 22.0%, expanding from 19.5% in FY’16. These investments in operational efficiency include business unit SG&A expenses, automation, sales/marketing, and reskilling efforts. Missing margin expectations as laid out by the company would be detrimental to investors’ confidence in management.

Lack of Value Added from M&A

While not an essential aspect of CTSH’s growth story, the company projects M&A to add 1-2% to mid-term revenue growth projections. These acquisitions are, however, a key aspect of CTSH’s culture of innovation and rapid advancement as the company brings in new people and ideas to help the company grow. If CTSH is not able to follow through and bring in the type of talent it needs, this could have an adverse impact on the improvement of its solutions.

Healthcare M&A Clients Delay Spending

An additional potential headwind to CTSH’s operations would be the extended delay of spend by its healthcare clients engaged in large-scale M&A activities. This could negatively impact CTSH’s significant Healthcare end-market, and fuel further negative sentiment from investors. While we do not assess this scenario to have a high probability, we acknowledge that this risk remains a potential headwind.

Spring 2019


MANAGEMENT

Francisco D’Souza: Founder, CEO & Vice Chairman of Board of Directors Co-founding CTSH in 1994, Mr. D’Souza has played an integral role in the vision and growth of the company. Since taking role as CEO in 2007, Mr. D’Souza has set CTSH’s strategic direction, promoting the company’s values and client-first culture, focusing on ensuring sustainable growth, and driving stockholder value. Under his tenure, CTSH grew revenue at a CAGR of 20.3% from $2.1B to $16.1B in FY’18, with the stock appreciating over 200%. He will step down April 1, 2019, maintaining his position on CTSH’s board and overseeing the CEO transition through June. Mr. D’Souza’s FY’17 pay was $10.2M, made up of $1.3M in cash and $8.5M in stock.

Brian Humphries: Appointed CEO & Former Vodafone Executive Named as succeeding CEO on February 6, 2019, Mr. Humphries is set to overtake CTSH’s reins on April 1, 2019. Mr. Humphries is transitioning from his role as CEO of Vodafone Business where he has been responsible for its global enterprise, consisting of all B2B customers, IoT, Cloud, Carrier Services, and Security Solutions. Vodafone Business accounted for nearly a third of the company’s FY’18 sales of $46.6B. With broad experience as a technology executive, Mr. Humphries is adept to handle CTSH’s position in a highly innovative environment.

Karen McLoughlin: Chief Financial Officer Appointed CFO in 2012, Mrs. McLoughlin oversees CTSH’s worldwide financial planning and analysis, accounting and controllership, tax, treasury, and internal audit functions. Mrs. McLoughlin joined CTSH in 2003 and prior to being appointed CFO served as Senior VP, Enterprise Transformation and Financial Planning and Analysis. In addition to her positions with CTSH, Mrs. McLoughlin serves on the BoD of Best Buy Co. Inc.

Insider Transactions

Spring 2019


COMPARABLE BENCHMARKING

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Spring 2019


VALUATION ANALYSIS

DCF Assumptions:

Our base case implies FY’19 revenues of $17.6B which represents +9.4% YoY growth. Over the course of the projection years, we foresee a 9.9% revenue CAGR in the base case. This falls within management’s mid-term growth targets of 7-11%. These projections represent our belief that CTSH will see steady growth from its more mature segments in Financial Services and Healthcare. Additionally, we are confident that CTSH can deliver on rapid growth in its smaller segments in Products & Resources and Communications, Media & Technology. As the company transitions to its digital offerings, we expect steady gross margin expansion with its higher-value services.

Spring 2019


DCF Sensitivity Analysis (Returns of 15%-30% in Green)

Spring 2019


Valuation Multiple Sensitivity Analysis (Returns of 15%-30% in Green)

Spring 2019


Valuation Multiple Sensitivity Analysis- Continued (Returns of 15%-30% in Green)

Spring 2019


FINANCIAL ANALYSIS

CTSH Segment Revenue Model

Our estimates for revenue growth lie towards the high-end of management’s mid-term growth targets of 7-11% CAGR. In the first chart, we outline the steady growth we expect CTSH’s financial services segment to achieve, between 4-5% YoY in the projection years. In the second chart at the bottom, we wanted to emphasize the potential impact that sustained MDD growth in Products & Resources and Communications, Media & Technology segments can have. In diversifying away from away from the company’s more mature segments, CTSH should benefit from hedging the risk of industry-specific cyclicality.

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Spring 2019


Total Revenue:

• From FY’15 to FY’18, CTSH’s total revenue grew from $12.4B to $16.1B, representing a 9.09% CAGR.

• Revenue growth from FY’15 to FY’18 is attributable to strong demand for technology consulting as enterprises continue to shift legacy business operations into the digital world.

• Total FY’18 revenue grew 8.9% YoY, from $14.8B to $16.1B, driven primarily by a continuation of strong sales growth across the Healthcare, Products and Resources, and Communications, Media and Technology end markets.

• 4Q’18 revenue of $4.1B (+7.9% YoY or +8.8% in constant currency), at the high end of the previously guided range and in line with analyst expectations.

• In 4Q’18, Banking and Financial Services continued to see slower growth at 2.8% YoY, driven by softness at three of CTSH’s top five clients. Despite pressure on these accounts, the rest of the banking portfolio continues to show good growth, indicating the issues are firm-specific rather than an industry trend. Furthermore, based on closed deals and late stage pipeline deals, management expects a recovery in the segment.

• Management’s full-year 2019 guidance indicates 7.0% to 9.0% YoY revenue growth. For 1Q’19, management guided for revenue growth of 7.5% to 8.5%.

Earnings:

• The company has beat on earnings every quarter since 3Q’08, with an average surprise of ~4.56% and an average price change of ~0.68%. Additionally, on average, the stock realizes a +4.62% price change.

• From FY’15 to FY’18, earnings per share appreciated at a 14.3% CAGR, increasing from $3.06 per share to $4.57 per share. The increase in EPS is attributable to strong topline growth across all end markets.

• In 4Q’18, CTSH posted earnings per share of ~$1.13 (+7.5% YoY) and revenue of $4.1B (+7.9% YoY), both in-line with analyst expectations.

• The Banking and Financial Services segment saw slower growth at 2.8% YoY. Despite three of Cognizant’s top five clients facing spending pressure, management is confident its closed deals and pipeline will lead to a recovery in 2019.

• The Products and Resources and CMT segments realized strong YoY revenue growth of 15.4% and 20.1%, respectively.

• By FY’21, the company is expected to increase EPS from $4.57 per share to $5.39 per share, representing a 5.66% CAGR. Key drivers of earnings growth will be the company’s high-growth transition to its higher-margin digital services/products.

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Spring 2019


Cash Flow & Capital Deployment

• From FY’16 to FY’18, free cash flow increased from $1.3B to $2.2B, despite declining net income, representing a CAGR of 30.1%. Primary growth in FCF during the time period was from FY’16 to FY’17, attributable to a sharp increase in non-cash items.

• We project Cognizant will generate ~$2.3B in FCF in FY’19.

• Moving forward, management intends to utilize approximately 50.0% of global FCF annually for dividends and share repurchases. By doing so, CTSH will maintain a dividend payout ratio of approximately 20.0%, while reducing the outstanding share count by approximately 1.0% annually. Furthermore, 25.0% of annual global FCF is intended to be used for acquisitions that enhance the firm’s digital capabilities by expanding geographic footprint.

Shareholder Returns

• In FY’18 the company repurchased ~15.6M shares, representing a value of ~$86M, a result of the company’s share repurchase program. The company is expected to utilize 30.0% of FY’19 FCF for share repurchases.

• In FY’18, CTSH paid ~$468M in cash dividends to shareholders, representing $0.80 paid per share, up from $0.45 per share in FY’17, which was the first year CTSH offered a dividend.

• Overall, we view the company’s initiatives to return value to shareholders through dividends and its share repurchase program as favorable for prospective and current shareholders.

Margins:

• Historically, Cognizant employed a “growth-at-all-costs” strategy, which adversely affected margins as the company would take on clients with less profitability. However, the company shifted focus in FY’17 towards “more high-value-added digital work with healthy margins.”

• From FY’16 to FY’17, net income margin expanded 130 basis points from 13.7% to 15.0%. However, from FY’17 to FY’18, net income margin fell back down to 14.3% as a result of pressure among three of Cognizant’s top five banking and financial services customers.

• For FY’19, management has identified four core focuses to expand operating margin including pricing levers, pyramid or enhanced utilization, corporate function spending, and business unit SG&A. These margin enhancements will add ~650 bps to operating margin, approximately 50% of accomplished in FY’18. The firm will further add 400 bps via investments in BPaaS, inorganic investments, reskilling, and automation. These changes are expected, in total, to expand non-GAAP operating margin from 19.5% in FY’16 to 22.0% in FY’19.

Margins Analysis

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Spring 2019


APPENDIX

Exhibit I: Summary of Investment Thesis

Exhibit II: Geographical Breakdown of Cognizant’s Office Locations (by country)

Spring 2019


Exhibit III: CTSH Historical M&A Activity (labeled by company type, year of acquisition)

Exhibit IV: CTSH Correlation Analysis (w/Owl Fund’s Current Technology Sector Holdings)

Spring 2019


Exhibit V: CTSH Analyst Recommendations (as of 01-March-2019)

Firm Analyst Reccomendation Target Price DateWells Fargo Securities Edward S Caso Jr outperform 82$ 03/01/19RBC Capital Markets Dan Perlin outperform 83$ 02/27/19

Wedbush Moshe Katri outperform 80$ 02/27/19Nomura Ashwin Mehta buy 83$ 02/27/19

Credit Suisse Charles Brennan outperform 85$ 02/26/19Susquehanna Financial Jamie Friedman neutral 63$ 02/25/19

Baird David J Koning outperform 84$ 02/22/19Cantor Fitzgerald Joseph D Foresi overweight 87$ 02/22/19

BMO Capital Markets Keith F Bachman outperform 88$ 02/21/19Zacks Investment Research Team Coverage hold 02/15/19

Edward Jones Josh Olson hold 02/13/19Societe Generale Richard Nguyen hold 76$ 02/12/19Daiwa Securities Louis Miscioscia buy 90$ 02/12/19Morningstar, Inc Andrew Lange hold 85$ 02/11/19Morgan Stanley Brian Essex Equalwt/Attractive 85$ 02/07/19

Argus Research Corp James Kelleher buy 100$ 02/07/19J.P. Morgan Tien-Tsin Huang neutral 83$ 02/07/19

Loop Capital Markets Joseph Anthony Vafi buy 94$ 02/07/19Cowen Bryan Bergin market perform 80$ 02/07/19

MoffettNathanson Lisa D Ellis neutral 80$ 02/07/19SunTrust Robinson Humphrey Frank Atkins buy 85$ 02/06/19

Jefferies Surinder Thind hold 70$ 02/06/19Needham & Co Mayank Tandon strong buy 90$ 02/06/19

William Blair & Co Maggie Nolan outperform 02/06/19KeyBanc Capital Markets Arvind Ramnani overweight 84$ 02/06/19

Evercore ISI David M Togut outperform 99$ 02/06/19Berenberg Georgios Kertsos buy 80$ 02/06/19

Oppenheimer & Co Glenn Greene outperform 80$ 02/06/19Wolfe Research Darrin Peller peerperform 75$ 02/06/19

HSBC Yogesh Aggarwal buy 95$ 01/03/19Goldman Sachs James Schneider Buy/Neutral 84$ 11/26/18

ISS-EVA Anthony Campagna buy 03/22/18Tigress Financial Partners Ivan Feinseth buy 07/12/16

CTSH Analyst ReccomendationsBuy 65.7% 23Hold 31.4% 11Sell 2.9% 2

Spring 2019


Exhibit VI: CTSH Debt Distribution

Exhibit VII: CTSH One-Year LTM P/E (w/median in green, average in blue)

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Spring 2019


Exhibit VIII: CTSH Two-Year LTM P/E (w/median)

Exhibit IX: CTSH Three-Year LTM P/E (w/median)

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Spring 2019


Exhibit X: Consolidated Financial Statements

Spring 2019


Exhibit XI: Ratio Analysis

Exhibit XII: Valuation Case Scenarios (Total Return incl. of dividend yield)

Spring 2019


DISCLAIMER

This report is prepared strictly for educational purposes and should not be used as an actual investment guide. The forward-looking statements contained herein are simply the author’s opinions. The writer does not own any Cognizant Technology Solutions Corporation (CTSH) stock.

TUIA STATEMENT

Established in honor of Professor William C. Dunkelberg, former Dean of the Fox School of Business, for his tireless dedication to educating students in “real-world” principles of economics and business, the William C. Dunkelberg (WCD) Owl Fund will ensure that future generations of students have exposure to a challenging, practical learning experience. Managed by Fox School of Business graduate and undergraduate students with oversight from its Board of Directors, the WCD Owl Fund’s goals are threefold:

• Provide students with hands-on investment management experience • Enable students to work in a team-based setting in consultation with investment professionals. • Connect student participants with nationally recognized money managers and financial institutions

Earnings from the fund will be reinvested net of fund expenses, which are primarily trading and auditing costs and partial scholarships for student participants.

Documents

Cognizant Technology Solutions Corp. (CTSH) · 3/11/2019 · Cognizant Technology Solutions Corp. (CTSH) is a leading custom information technology consulting, technology services,