Outsourcer Cognizant Moves Up Non-India Value Chain

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India is still important to outsourcing specialistCognizant Technologies Solutions ( CTSH ).

Most of its contracted work gets done there. A lot of that work remains basic software coding and testing, which can be done by Indian software engineers for about half the cost as in the U.S., where most of its customers are based.

But Cognizant is not a one-trick pony. It has increasingly been performing higher value work that's not sent to India at all, such as consulting and business-process services.

For example, in a mid-year deal with retirement and insurance firm ING, Cognizant agreed to take over ING's U.S.-based business-process facilities in Iowa and North Dakota and hire more than 1,000 ING employees working in them.

"ING didn't say, 'Take these jobs and relocate them to India,'" said Citigroup analyst Ashwin Shirvaikar. "They required Cognizant to build up their U.S. presence. It's outsourcing in the U.S., but Cognizant can bring best practices to the table and make it more efficient."

Full Circle

In a way, outsourcing has come full circle as Cognizant and its peers have expanded in size and scope, Shirvaikar says.

"When outsourcing first started, you did it in the U.S., but you did it cheaper. Then things started going to India," he said. "Now clients are savvier. Sometimes, they send some types of work to India and now they say it might be cheaper to do (other work) in Iowa compared to New York, the West Coast or Chicago."

A Morningstar analyst says Cognizant hires more locals in "client facing" involvements outside India than its peers, who more typically bring people in from India.

"They follow a hybrid model of onsite and offshore," said the analyst Swami Shanmugasundaram.

Unlike other outsourcers with largely India-based operations, such asInfosys ( INFY ),Wipro ( WIT ) and HCL, Cognizant isn't even based in India. It's headquartered in Teaneck, N.J., closer to many of its customers in financial services, health care and other verticals.

Almost 80% of its revenue is generated in North America, which saw a 20% jump in sales in Q3 over the prior year, with financial services accounting for the biggest slice of the pie.

Total revenue grew 18.2% over the earlier year to $1.8 billion while earnings rose 25% to 91 cents a share.

Cognizant's second largest region is Europe, which accounts for 16% of revenue. Cognizant was late to Europe and has a smaller presence than other outsourcers, the Morningstar analyst says.

But Cognizant's revenue in Europe has been growing in mid-to-high single digits as customers dealing with the region's economic problems turn more to outsourcers such as Cognizant to save money.

And a lot of Cognizant's work, such as consulting, is staying in Europe. In late July, Dutch-basedRoyal Philips Electronics ( PHG ) hired Cognizant to provide a range of consulting and application services to help consolidate and enhance its global information-technology footprint.

"Cognizant has to first provide consulting to change the processes that Philips uses for some of its businesses," Shirvaikar said. Then it will help implement and run them, he adds.

Though financial terms weren't disclosed, Shirvaikar estimates the contract could mean more than $50 million to Cognizant over three years. It could be a lot more if the contract is extended.

Citigroup's recent quarterly surveys with chief information officers of some 260 companies indicates that companies that do business with Cognizant generally want to spend more money with it in the future, Shirvaikar says.

"Cognizant easily has the best record," he said.

Cognizant intentionally keeps margins lower than peers, at 19% or 20%, to keep prices flexible and low to win business and market share. One result: it's been growing faster than its peers.

But as it's gotten bigger, growth has been slowing due to what analysts call "the law of large numbers." An uncertain economic climate has also caused Cognizant and its peers to tamp down their growth forecasts.

Revenue Forecast

Cognizant's revenue forecast for 2012 went from 23% early in the year to 20% later.

Last year, revenue rose 33% following a 40% gain in 2010 and 16% in 2009, the height of the economic downturn.

Many investors base their following year's revenue expectation on an 8-K filing setting out future management compensation based on certain performance milestones.

In a recent filing, the growth range for 2013 equated to 12% on the low end to 25% at the high end. That compares to 18% to 32% for 2012 and 19% to 34% for 2011.

Citi's Shirvaikar pointed out to clients that 2013's "implied deceleration" is similar to the 2010 level of 12% to 24%, which was set in 2009. He thinks it reflects a higher revenue base (the law of large numbers) but also uncertainty.

Analysts polled by Thomson Reuters expect both revenue and profit growth of 20% this year and 17% next year.

Though that's a slowdown, it's still industry leading growth.

"The overall IT services industry is expected to be flat in 2013," Shanmugasundaram said. "The offshore IT services industry is expected to grow around 10% next year."

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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