Cognizant 3QCY10: Positive implications for Indian IT: JPMorgan

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India IT Services
Cognizant 3QCY10: Positive implications for Indian IT
only marginal despite Cognizant's second successive
quarter of double-digit sequential growth


Cognizant (covered by our US analyst Tien-Tsin Huang) reported strong 3Q10
results, well ahead of its own guidance: Revenues grew by an impressive 10%
Q/Q to US$1217MM (vs. guidance of ‘at least $1175MM’). The company
attributed good growth to continued growth in discretionary projects – as
indicated by the 14% Q/Q growth in Application Development segment. Notably,
this marks the first instance in a single quarter when 3 of the Big 4 in Indian
IT (TCS, Infosys and Cognizant) registered double digit Q/Q revenue growth.



• Growth was broad-based: BFSI segment grew 10.5% Q/Q, buoyed partly by
continued M&A integration, Healthcare grew 7.4% Q/Q, retail-manufacturing,
logistics segments grew by 13.3% Q/Q, and the ‘Others’ segment, including
telecom, and media hi-tech, saw a 9.5% Q/Q increase. Notably, Europe geography
also grew 14.7% Q/Q with revenues from the UK growing 18% Q/Q. In this
quarter (Sep-10), Europe grew faster than the company average for all of the
Big 4. Net headcount (technical) increased by 6460 people, to 89,625 pointing to
robust people addition. Quarterly attrition was at 21.8% (versus 20.7% in the
previous quarter).

• CY10 revenue growth guidance raised to at least 39% revenue growth: 4Q10
guidance of 4.5% Q/Q US$ revenue growth to US$ 1.27bn is in line with the
guidance of Infosys. CY10 guidance was increased to 39% revenue growth (from
36% earlier) on the back of the 3Q10 beat.

• Pent-up demand flushing through, beginning to see signs of pricing increase:
Cognizant indicated that pent-up demand partly contributed to the good growth in
the quarter (as well as 2QCY10), but would wind down going forward, which
reflects in its 4QCY10 revenue guidance Also, BFSI M&A integration projects are
likely to wind down in the coming quarter. Cognizant indicated that discretionary
projects started in this quarter would drive the growth in coming quarters and
clients are willing to engage in price increase discussions, given the increased
attrition rates and wage pressures in the improving macro environment.
• Takeaways for Indian IT: only slightly positive on an incremental basis. This
is because: Cognizant is generally ahead of the curve in capturing spikes in
demand. Also, we believe that a good proportion of Cognizant's incremental
growth accrues from market-share gains, particularly its likely higher share in
discretionary type of work. Thus, the flow-through impact on Indian IT while
positive is likely to be of lesser magnitude.

Investment view: Fundamentals continue to be good for Indian IT players but we
would be wary of extrapolating Cognizant’s performance to all Indian IT
(historically Cognizant has grown much faster than Indian IT). Cognizant's results
do not offer us comfort that Indian IT can outperform 23-25% revenue growth
expectations in FY12E, which is essential to drive absolute share price upside (as
per our Sep-11 PTs) beyond 10-12% from current levels over 12 months. TCS
(OW) remains our top pick among the Indian IT large-caps given its ability to
crank up volume growth ahead of its Indian IT peers (Infosys/Wipro).