Cognizant Technology Solutions Corp (CTSH) Rises as Infosys Ltd ADR (INFY) Looks for a Messiah

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The co-founder of India’s technology giant Infosys Ltd ADR (NYSE:INFY), N.R. Narayana Murthy, has returned to the company amid shareholders’ demand for a turnaround following the poor performance of the business.Starting this month, 67-yeas old Murthy becomes the new executive chairman of Infosys for a period of 5 years.

Murthy, who co-founded the software firm in 1981, was the executive chairman between 2002 and 2006 and during that period, Infosys Ltd ADR (NYSE:INFY)’s revenues quadrupled to $2.15 billion. Since 2006, he remained with the company as a non-executive chairman, but retired later in 2011 after the business has struggled due to changing market dynamics. The global economic slowdown and the cost cutting initiatives by some of its biggest clients in the U.S. and Europe were cited by the management as the main reasons behind its problems.

The overall macroeconomic environment for tech-outsourcing firms has been challenging, and very few improvements are expected in the near term. The world’s second-largest technology consulting company, Accenture Plc (NYSE:ACN), and German powerhouse Siemens have also indicated a decline in future IT spending by other firms, particularly in the U.S. and Europe. Infosys Ltd ADR (NYSE:INFY) gets more than 80% of its revenues from North America and Europe so naturally, it has been struggling.

Infosys Ltd ADR (NYSE:INFY)Accenture Plc (NYSE:ACN) is itself moving aggressively in digital marketing services sector through acquisitions, such as those of Fjord and avVenta. More recently, Accenture has agreed to acquire the e-commerce and ad-consultancy firm Acquity for $316 million. I believe that through these measures, Accenture will become more competitive in the industry by offering superior services to CMOs and ad-agencies. However, in the short term, due to the tough economic environment indicated above, shareholders should expect little growth in the current fiscal year. The company believes that it will touch the lower end of its 5%-8% revenue growth guidance; the markets are expecting just 5.1%.

However, despite the challenges, Infosys Ltd ADR (NYSE:INFY) shareholders aren’t convinced. As Infosys has fallen, its rivals have continued to rise. In fact, Infosys’s growth has lagged behind India’s domestic outsourcing industry average growth. Infosys is targeting a growth of 6%-10% while the Indian IT sector is expected to post an average growth rate of 12%-14%.

In last two years, India’s software outsourcing market leader Tata Consulting Services and nearest rival Cognizant Technology Solutions Corp (NASDAQ:CTSH) have easily outperformed Infosys Ltd ADR (NYSE:INFY). In last two years, from India’s IT sector, Infosys’s market share has remained frozen at 6.9%, while TCS now gets 10.7% of the market’s overall revenues, as opposed to 9.3% two years ago.

While Tata Consulting Services, which was already bigger, was getting an even greater share of the market, I believe that a greater symbolic blow came from Cognizant Technology Solutions Corp (NASDAQ:CTSH), which is relatively a newer entrant, when last year, it overtook Infosys Ltd ADR (NYSE:INFY) as the second leading Indian IT firm in terms of revenues.

Cognizant Technology Solutions Corp (NASDAQ:CTSH) is the fastest growing firm in India’s IT sector. According the research firm Gartner, the five biggest Indian IT companies posted growth of 13.3% in 2012, with Cognizant at the top with an enviable growth rate of 20.1%, far above the industry’s average.

In its most recent quarterly results, Infosys Ltd ADR (NYSE:INFY) met the earnings but missed the revenue estimates. The company reported 18.1% year-over-year increase in revenues to $1.84 billion while its net income rose 3.4% to $421 million.

Cognizant Technology Solutions Corp (NASDAQ:CTSH) has also released its quarterly results that topped the estimates. The company’s revenue rose 18% in the quarter, matching Infosys’s growth, to $2.02 billion, below analysts’ expectations of $2.11 billion but its profits rose an impressive 16.6% to $284.2 million. This translates into adjusted earnings of $1.02 per share, above market’s expectations of $0.97. Moreover, the company netted $180 million more in sales than Infosys.

Over the years, the revenue growth of both Infosys Ltd ADR (NYSE:INFY) and Cognizant Technology Solutions Corp (NASDAQ:CTSH) has fallen due to identical reasons, but over the long run Cognizant, as indicated above, has remained ahead of Infosys. Despite the current increase in Infosys’s sales, which were above market’s expectations, I expect Infosys’ growth to trail behind Cognizant’s in coming quarters.

Infosys is significantly more profitable than Cognizant Technology Solutions Corp (NASDAQ:CTSH), as shown in the graph below. But investors should note that Infosys Ltd ADR (NYSE:INFY)’s profitability has wobbled while overall, in the last two years, its quarterly profit margin has fallen by 2.2 percentage points. On the other hand, Cognizant has been far more consistent in its ability to maintain its profit margin at around 14%.

One of the main reasons behind Cognizant’s growth is its effective reinvestment strategy. As indicated above, Cognizant Technology Solutions Corp (NASDAQ:CTSH) is not as profitable as Infosys, but this is because the company has been sacrificing its margin for long-term growth by increasing its sales expenditure. Unlike most of its rivals, Cognizant has made market share its top priority; this is how the company has been operating since its inception. Some of its rise can be attributed to inorganic growth through acquisitions. It is currently planning to acquire six companies from Germany’s C1 Group, one of the largest privately owned system integrators in Germany. Like most of its domestic and international rivals, Cognizant is also making significant strides into the more lucrative consultancy and systems integration business.

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