Cognizant to Buy Six Companies

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Cognizant Technology Solutions Corp. (CTSH) recently announced that it has entered into a definitive agreement to acquire six companies of Hamburg, Germany based C1 Group. C1 specializes primarily in SAP implementations. However, the company did not disclose the financial terms of the agreement.

The six companies namely btconsult GmbH, C:1 Solutions GmbH, psc Management Consulting GmbH, C:1 SetCon GmbH, Enterprise Services AG and C:1 Holding GmbH mainly serve manufacturing & logistics, energy & utilities and financial services industries. As per the agreement, more than 500 professionals associated with these companies will join Cognizant post merger, which is expected to close in the first quarter of 2013.

Cognizant continues to earn majority of its revenue from North America (78.5% in fiscal 2011) followed by Europe (17.9% in fiscal 2011). Others, which include Asia, Pacific and Latin America, contributed approximately 3.6% in fiscal 2011. However, at the end of fiscal 2011, year-over-year revenue growth in Europe slowed down to 28.3% from 41% year-over-year growth at the end of fiscal 2010. In contrast, revenue growth in North America was 34% at the end of fiscal 2011, a slight decline from 38.1% reported at the end of 2010.

In the first nine months of 2012, revenue growth in Europe was lowest, up 5.6% from the comparable prior-year period. At the same time, revenue growth in Others was 44.2% while North American revenue growth was 23.7%. We believe that sluggish European growth not only reflects overall volatile macro-economic condition in the region but also the fact that Cognizant has less penetration in the region compared to its peers such as Infosys Technologies (INFY) and Wipro Ltd. (WIT).

Among all the three regions, Cognizant has least number of development & delivery facilities in Europe. The company has 3 in Amsterdam, Budapest and London compared with 12 in Asia-Pacific (expanded over 53 locations), 8 in North America and 3 in Latin America. The current deal will expand Cognizant’s presence in Germany (Europe’s strongest economy) and Switzerland (important financial hub), which will further boost its penetration going forward.

We believe that Europe is a significant growth market for Cognizant due to the fact that the businesses in the region are looking for outsourcing partners in order to save cost. The acquisition will help Cognizant to expand its operations in Europe. We believe that the deal will help it to attract new customers as well as serve its existing customers better over the long term.

Over the years, acquisitions have been an integral part of Cognizant’s growth story. Cognizant acquired nine companies in the last three years and has spent approximately $82.8 million (fiscal 2011), $33.9 million (fiscal 2010) and $68.6 million (fiscal 2009) for them.

We believe that Cognizant will continue to pursue strategic acquisitions in order to expand its operational market as well as eliminate competitors. This will not only boost its top line and profitability but will also provide it a competitive edge going forward.

We maintain our Neutral recommendation over the long term (6-12 months). Currently, Cognizant has a Zacks #2 Rank (Buy).

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