Activist Investor Elliott Management To Cognizant: It's Time To Shake Up Board, Buy Back $2.5B Shares

Activist technology investment fund Elliott Management Monday called for $13.5 billion solution provider behemoth Cognizant to shake up its board of directors and buy back $2.5 billion in shares as part of what it called a value enhancement plan aimed at driving shares up by 50 percent to 69 percent over the next year.

The activist offensive is spearheaded by Elliott Management Senior Portfolio Manager Jesse Cohn, who has successfully brought high-profile activist actions against a wide range of technology companies including Citrix Systems, Riverbed Technologies and BMC Software.

Most recently Cohn acquired a stake in identify theft protection company LifeLock, which is being acquired by Symantec.

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"Over the last five years, Cognizant has underperformed its core IT services peers by 83 percent despite growing revenue at a 22 percent CAGR (compound annual growth rate) versus the peer average growth of a 16 percent CAGR over the most recent fiscal quarters," wrote Cohn in a letter to the Cognizant board of directors with an attention to Cognizant Chairman John Klein and Cognizant CEO Francis D'Souza.

The activist bid comes with Elliott taking a four percent stake in Cognizant, No. 7 on the 2016 CRN Solution Provider 500, representing a market value of $1.4 billion.

"We believe that Cognizant can achieve a value of $80 – $90 plus per share by the end of 2017, representing upside of 50 percent to 69 percent in just over a year," wrote Cohn. "This level of value creation is unique in today’s market for any company, much less one with a more than $30 billion market capitalization."

Cognizant did not return a call for comment as of press time.

Shares of Cognizant were up $4.28, or eight percent, to $57.53 in the wake of the activist offensive.

Martin Wolf, president of martinwolf M&A Advisors of Walnut Creek, Calif., one of the top channel investment advisory deal-makers, said the Elliott Management letter comes from a "very responsible group that puts its money where its mouth is with a technology background and focus."

Wolf said the Elliott Management and private equity activity in the solution provider market shows there is "hidden value" in the channel.

"It is a market that is overlooked and, as a result, it is less efficient," he said of the channel. "The data that we report shows increased continued private equity interest in the channel. These are smart guys that don't follow trends and create their own thesis."

Wolf said he expects to see continued "shareholder activism" because it has been successful.

As for the board shakeup, Cohn pointed out in his letter that more than "half of Cognizant's director have been with the board" for at least nine years including four with more than 13 years.

"Given the sustained share price underperformance at Cognizant, we believe directors with new experience, skills and perspectives would be welcome," wrote Cohn. "Such new perspectives are especially important because Cognizant also has an incredibly long-tenured management team."

Cohn called for the formation of an operating committee of the board tasked with direct oversight for implementing the Elliott Management Value Enhancement Plan.

"The formation of such a committee would be the best way to bring the experiences and skills of the new directors directly to bear on the challenges Cognizant faces today," wrote Cohn.

The Elliott Management Value Enhancement plan also calls for a $2.5 billion share repurchase to be completed over the first half of fiscal year 2017 which begins Jan. 1. That plan would be funded with $1 billion of domestic cash and an incremental $1.5 billion of new debt.

Even with that stock buyback plan, Cognizant would have $3.5 billion of net cash existing fiscal year 2017 and a "net cash level of over 1.0 x EBITDA (earnings before interest, taxes, depreciation and amortization) in line with peers," wrote Cohn.

Cohn also called for Cognizant to immediately institute a long-term capital return program with a commitment to return 75 percent of U.S. free cash flow to shareholders" and a 1.5 percent dividend yield.

Elliott Management said its plan provides "ample firepower for continued acquisitions" by Cognizant. Specifically, Elliott is pressing for Cognizant to use 25 percent of annual U.S. free cash flow as well as $1 billion in foreign cash to make acquisitions.

Cohn said in the letter that the Elliott Management "base case" assumes that Cognizant exits fiscal year 2018 with $5.3 billion of net cash on hand.

The activist bid comes after Cognizant President Gordon Coburn resigned in September after two decades with the company and the company itself said it was investigating whether it violated the U.S. Foreign Corrupt Practices Act (FCPA).

Cognizant at that time said it had launched an internal probe into whether certain payments relating to facilities in India were made improperly and in possible violation of the FCPA or other laws, according to a filing with the U.S. Securities and Exchange Commission Friday. The probe is currently focused on a small number of company-owned facilities.

The investigation is being conducted under the oversight of Cognizant's Audit Committee, Cognizant said, and is receiving the assistance of outside counsel. Cognizant voluntarily notified the U.S. Department of Justice (DOJ) and SEC about the investigation, and the company said it is fully cooperating with both agencies.