SAN FRANCISCO -- Shares of tech services firm Cognizant ( CTSH) rebounded from a
severe selloff on Tuesday that analysts called unwarranted. Cognizant shares had recently gained $1.32, or 4.1%, to $33.32, in the wake of a pronounced stock market downturn. That gain helped restore some of Cognizant's market value after investors bolted on Tuesday, sending shares down more than 19%. Concerns about the company's lower-than-expected fourth-quarter guidance sparked the selling. Cognizant said that the typical fourth-quarter "budget flush," or the flurry of spending, didn't materialize because of concerns regarding macroeconomic issues. Credit market turmoil and high oil prices are stoking fears that consumers will rein in spending and send the economy into a recession. But analysts say that the lack of a budget flush indicates that companies are not cutting their budgets, but merely spending in line with them rather than overspending as usual. As a result, analysts say investors gave too much weight to the fourth-quarter outlook and overlooked Cognizant's bullish 2008 prospects. Surveys from Cognizant as well as Citigroup show that information technology managers plan to increase their budgets modestly for the coming year. Citigroup's survey found that fewer than 20% of chief information officers expect macroeconomic concerns like the credit market turmoil to affect their budgets. Investors' skittishness stems in part from the fact that the fourth quarter is a critical time for IT managers and CIOs to begin planning their 2008 budgets. IBM ( IBM) fanned investors' fears in October when it said that weak third-quarter hardware sales resulted largely from cutbacks in purchases from financial services firms.
It's unclear, however, how much the cutbacks stemmed from contractions in discretionary spending or from delays that arise as companies use up existing tech resources before splurging on IBM's newest servers. Some analysts have said that IT services firms like Cognizant stand to benefit from a weaker economy that forces companies to pare spending by outsourcing IT operations and processes. Cognizant executives raised this point during a conference call with analysts on Tuesday, citing responses from their customer survey. Citigroup analyst Ashwin Shirvaikar said that the fears of a severe spending falloff are unwarranted, and that the portion of IT budgets earmarked for offshore projects should increase as a proportion of total 2008 IT budgets. Citigroup has provided investment banking services to Cognizant in the past 12 months. Cognizant CFO Gordon Coburn said revenue from third-quarter development work that is generally considered discretionary and vulnerable to budget cuts actually grew at 11% from the previous quarter, outpacing a 6% gain in more stable maintenance work. Coburn attributed this to increases in the amount of IT projects that U.S. companies assign to software engineers based in India. Cognizant still has a stacked bench of idle employees in India that it can use to take on new project work. Its offshore utilization rate, a measure of how much it is using its employees in India, stands at 58%, lower than its competitors. Infosys ( INFY), for example, has an offshore utilization rate of 70%.
That means Cognizant doesn't need to hire as many employees for new projects, keeping its overhead stable as its revenue increases. This can help offset the dual pressures of a rising currency and wage inflation that have squeezed the profits of India-based IT outsourcing firms. In the third quarter, Cognizant's operating margins contracted 50 basis points to 19.7%, excluding one-time items and stock-based compensation expenses, but still remained on the high end of its target range of 19% to 20%. Analysts concurred with Cognizant's forecast that its 2008 revenue will outpace that of its rivals. "Most of Cognizant's competitors should see growth in the low 30% range year over year," said Ashish Thadhani of Gilford Securities. "For Cognizant, we think 40% a good place to start." Thadhani doesn't personally own shares of Cognizant. Gilford Securities has not performed investment banking work for the company in the past 12 months.