Cognizant’s ambitious acquisition of Belcan raises questions

Bengaluru: On Monday, Cognizant Technology Solutions Corp. announced it is buying Belcan LLC, a Cincinnati, Ohio-based engineering, research and development (ER&D) service provider, for $1.3 billion.

Cognizant would pay $1.19 billion in cash and $97 million in shares to complete this acquisition, making it the New Jersey-headquartered company’s second-largest buyout.

A decade back, in 2014, Cognizant paid $2.7 billion to buy Trizetto, a healthcare software firm. A year later, in 2015, Propulsion Acquisition, which runs business under the brand Belcan, was bought by AE Industrial Partners, a private equity firm. AE Industrial Partners did not disclose the financials when it bought Belcan in 2015.

Also Read: Cognizant to acquire ER&D services firm Belcan for $1.3 billion

Surprisingly, there is a lack of clarity on some of the most elementary aspects of this acquisition.

First, just exactly how big is Belcan?

In an investor presentation, Cognizant said Belcan employed 6,500 people. Further, the presentation stated that Belcan had posted an 8% compounded annual growth over the last two years. Although Cognizant did not disclose Belcan’s revenue in 2023, the investor presentation said that Belcan is expected to clock $800 million in revenue in 2024. 

But privately-held Belcan’s environmental, social and governance (ESG) reports for 2022 and 2021 paint a different picture. The 19-page ESG reports claim the company had over 10,000 employees in 2022 and 2021. The company has not published its ESG report for 2023.

When a analyst quizzed the management in a call scheduled to discuss the acquisition on Monday, Cognizant’s chief financial officer Jatin Dalal attributed this difference to “headcount fluctuation”! 

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Why is the difference in the number of employees a big deal?

Integration is the biggest risk during the acquisition of a company. The task becomes more complicated when most of the employees are based in the US or the UK. Belcan claims that 85% of its staff are in America and Europe.

A second point is related to revenue.

The ESG report states that Belcan had about $1 billion in revenue in 2022 and 2021.

Cognizant expects Belcan to have $800 million in revenue this year. This would imply a 20% loss from the $1 billion in revenue in 2022.

Simply put, Belcan’s revenue has declined in recent years, instead of growing. 

It is surprising that Cognizant, which does not count any promoter, failed to share these basic details about an acquisition with its investors.

An email sent to the company seeking answers to these questions went unanswered.

A third wrinkle is a lack of clarity on the profitability.

In the call with analysts, Cognizant declined to spell out either the gross margin or operating margin.

“We have not broken it down,” CFO Dalal said. “But suffice it to say that they are healthy margin for onsite work. It reflects a competitive edge”

An S&P Ratings note from July 2022 states that Belcan’s debt to Ebitda ratio, or leverage, was 5 to 5.5 times in 2022. When compared with Cognizant’s overall leverage of less than 1, Belcan has a high level of debt. This is something that Cognizant has not shared. 

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So why did Cognizant buy Belcan?

S Ravi Kumar, who took over as the CEO in January last year, said in an interaction with analysts that Belcan’s acquisition gives Cognizant four advantages. First, it allows Cognizant to scale up its business in the ER&D market.  Second, it complements Cognizant’s current services offering and allows it to diversify into the aerospace and defence sectors. Belcan gets about three-fourths of its current business from customers in the aerospace and defence sectors. Access to over 6,500 employees in the ER&D services is a third reward. Finally, Cognizant will cross-sell its service offerings to Belcan’s clients, and which, according to the management, could yield $100 million in annual synergies in three years.

But not all are impressed.

Bank of America Securities analyst Jason Kupferberg reiterated a Sell rating on Cognizant on Monday.

Kupferberg has expressed concerns about the integration and the near-term financial impact. Cognizant expects a 40-basis-point decline in profitability this year on account of the acquisition. Further, the acquisition is expected to be neutral to Cognizant’s earnings per share (EPS) in fiscal 2025 and only accretive to fiscal 2026’s adjusted EPS.

A few executives argue that the acquisition is just another instance of buying revenue.

Cognizant, which follows a January-December fiscal year, ended with $19.35 billion in revenue last year. Its revenue in 2022 was $19.43 billion.

This year, Cognizant expects its full-year revenue to be between $18.9 billion and $19.7 billion.

"Considering the company will book about one quarter of revenue ($200 million), it appears it is being done more to offset the loss in revenue for this year," said the executive.

Cognizant loves acquisitions.

In 2023, Cognizant spent $409 million on acquisitions, $591 million in dividends and $1.06 billion on share repurchases. Since 1 January 2019, Cognizant has spent $3.5 billion on acquisitions and $2.6 billion and $7.12 billion on dividends and share repurchases, respectively, according to a Mint analysis. 

Including this latest acquisition, Cognizant has spent $4.8 billion on acquisitions and returned twice this amount or about $9.7 billion to shareholders through share repurchases and dividends.

Save for Accenture Plc, Cognizant has spent the most on acquisitions among its rivals, including Tata Consultancy Services Ltd, Infosys Ltd and HCL Technologies Ltd. 

How did investors react?

Cognizant's announcement came before the market opened for trading on Monday. Investors appeared to have stamped their approval as shares rose 2% to end at $67.25 on Nasdaq.

However, in post-market hours trading, Cognizant shares reversed the gains and were down 7.32%.

One of the reasons investors could possibly have been sanguine could be the management’s comments made in the call on Monday.

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Cognizant CFO Dalal said the company expects revenue growth in the second quarter to be in the upper band of its stated guidance.

On 1 May, when Cognizant declared its earnings for the January-March period, the management said it expected revenue in the April-June quarter to be between $4.75 and $4.82 billion. Considering Cognizant ended with $4.76 billion in revenue in the first quarter, this would translate to a sequential dollar revenue growth of 1.2%.

Dalal’s statement suggests that Cognizant expects some sequential growth in the current April-June quarter.

“We expect it (Belcan) to be a growth vector for the company,” Ravi Kumar told analysts on Monday, expressing confidence.

There is merit in why investors need to be skeptical of management’s sanguine outlook.