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Investing in Cognizant Technology Solutions (NASDAQ: CTSH)

Written By Briton Ryle

Posted September 16, 2014

As new healthcare insurance laws bring thousands of businesses into the healthcare system, the tremendous rise in demand for healthcare payment and processing services has spurred an inordinate amount of mergers and acquisitions across the healthcare space.stethoscope healthcare doctor

There has also been a tremendous need for cost cutting, as many of these new participants are small businesses with as few as 50 full-time employees and small healthcare budgets.

Cognizant (NASDAQ: CTSH), for example, announced yesterday that it will be acquiring privately owned healthcare payment services and information technology company TriZetto Corporation for $2.7 billion in cash.

Cognizant seems to be, well, cognizant of the enormous growth potential in healthcare IT, and it is aggressively expanding its influence over the sector.

“Healthcare is undergoing structural shifts due to reform, cost pressure and shifting responsibilities between payers and providers,” Cognizant CEO Francisco D’Souza underscored the challenges facing his industry. “This creates a significant growth opportunity, which TriZetto will help us capture. We are excited that the integrated portfolio of capabilities across technology and operations will uniquely position us to help clients drive higher levels of operational efficiency, while re-imagining care for the future.”

Just how significant a growth opportunity is this acquisition of TriZetto for Cognizant and its shareholders? Might this provide investors an opportunity to benefit from the acquisition as well?

The Acquisition

With over 50 service centers and more than 187,000 employees, Cognizant is already a leader in information technology consulting and business process services worldwide, operating in three main segments: Financial Services, Healthcare, and Manufacturing/Retail/Logistics.

Among its many services offered are the design, development, and integration of information technology, including “big data” – assisting clients in managing the volume, variety, velocity, and complexity of personal data. Cognizant then enables clients to utilize these information systems across a variety of channels, including mobile and cloud-based applications.

For its part, “The TriZetto Corporation develops, licenses and manages software solutions for the US health insurance industry and provides critical enterprise software products, akin to those of SAP’s ERP platform for a manufacturer,” the press release introduces. “TriZetto solutions enable the healthcare interactions of millions of people in the U.S. every day.”

In the merger, TriZetto will be handing over to its new owner a portfolio of “more than 200 clients, including 16 of the top 20 U.S. health plans and four of the top five pharmacy benefit management companies,” the press release informed.

With some 26% of Cognizant’s business activity in the healthcare sector, “this acquisition is a natural fit,” company President Gordon Coburn extolled the purchase. “It represents a great opportunity to integrate services across our three horizons—traditional IT services; high-growth businesses such as management consulting, business process services and IT infrastructure services; and emerging delivery models—and provide even greater value to our clients.”

Not to mention great value to the company too. With its healthcare segment generating some $8.9 billion last year, Cognizant’s purchase of TriZetto is expected to add another $1.5 billion in revenues over the next five years, growing its healthcare arm by more than 3% through this one acquisition.

Investors Unimpressed, But They’ll Come Around

Despite management’s optimism over the purchase, Cognizant’s shareholders found the acquisition tough to swallow, punishing the acquirer’s stock by more than 1% yesterday. And this comes after a brutal 13% decline in just one day in early August when the company reduced its annual revenue forecast as a result of delays closing a number of service deals.

Yet there is ample reason to expect investors to come around eventually and continue lifting Cognizant’s stock higher in time, continuing its stellar run since the 2009 recovery began. Since then, CTSH has climbed over 330%, beating both the S&P 500 broader market index and the SPDR Healthcare Sector ETF (NYSE: XLV) which are both hovering around 160%, as noted in the graph below.

cognizant technology solutions corporation


One reason investors are expected to warm up to the transaction eventually is the method of payment – just cash and debt, no stock – thereby not sacrificing any future profits.

“Cognizant intends to finance the [$2.7 billion] transaction through a combination of cash on hand and debt, and has secured $1 billion of committed financing in support of the transaction,” the press release reveals.

According to Cognizant’s last quarterly report of June 30th, the company had absolutely zero debt. After this acquisition of TriZetto, the company will have just $1 billion in debt equalling a mere 3.7% of its current $26.94 billion market cap. With revenues of $9.6 billion, an EBITDA of $2.02 billion, and net income of $1.36 billion over the trailing 12 months, the newly acquired debt represents just 6 months’ worth of earnings and 9 months’ worth of net income – making it an easy load to burden.

Positive Outlook

The recent pullback in Cognizant’s stock, therefore, seems to be nothing more than an adjustment of the stock price aligning it to slightly lower projections and the increased expense of the acquisition. Yet it shouldn’t take long for the stock price to rebound, given management’s outstanding performance.

Over the past 12 months, the company has managed profit and operating margins of 14.22% and 19.09%, generating returns on assets and equity of 14.60% and 22.17% respectively, with quarterly revenue and earnings growth of 16.50% and 23.80% – far outpacing most in its industry.

Estimates, despite having been revised down in August, have since been revised up twice in the last 7 days. Q3 and Q4 earnings per share are each expected to come in at 60 cents, better than last year’s 53 cents for each quarter. Annual 2014 EPS of $2.39 is expected to beat 2013’s $2.02, with 2015’s EPS rising even higher to $2.72, representing 18% and 14% annual growth respectively for this year and next.

While CTSH’s growth estimates are expected to underperform its industry, sector, and the S&P broader market in Q3 and Q4 of this year, its 2014 annual growth of 18.30% is expected to beat them all. However, 2015’s growth estimated of 13.80% is expected to beat only the broader market’s 13.00%, while trailing behind the industry’s 25.00% and the sector’s 23.40%.

Even so, analysts rate the stock at strong buy at 1.8 out of 5, with a low price target of $44.40 (where the stock currently is), a mean target of $51.55 (16.3% higher), and a high target of $61.00 (37.7% higher). Out of 24 analysts this month, 8 rate CTSH a strong buy, 13 a buy, and 3 a hold, while none rate it as underperform or as a sell.

Joseph Cafariello