Last week, Cognizant released results for Q4 and full year 2015. At first glance, results looked strong. Q4 revenues were $3,232.5m, up 17.9% y/y, up 16% in CC, and adjusted operating margin was 19.6%, up 18 bps y/y and in the middle of the company's target range of 19%-20%.

If we look at Q4 2015 revenue performance in Cognizant’s two largest vertical groups:

• Financial Services, was up 16.6% to $1,308m, with the strongest growth in insurance
• Healthcare (includes payer, pharma, biotech and medical devices) was up 23.2% y/y  to $952m, with the strongest growth in life sciences

These two vertical groups accounted for 70% of Cognizant’s total revenues in Q4, and for 74.5% ($366m) of the company’s overall y/y topline growth.

So why did Cognizant’s share price take a bit of a dive following these results, and furthermore drag down some other stocks with it, before showing some recovery on Friday?

The fact that sequential growth, at 1.4%, was below that reported by Accenture and Infosys may have had something to do with it. At NelsonHall we largely ignore sequential growth, as it ignores seasonality impacts, which may vary slightly from vendor to vendor, depending on their client base.

But the main concern was over Cognizant’s soft guidance for Q1 and full year 2016. Revenue guidance for:

• Q1 2016 is in the range of $3.18bn - $3.24bn, y/y growth in the range of 9.2% to 11.3%
• Full year 2016 is in the range of $13.65bn - $14.20bn, or growth in the range of 9.9% to 14.3%: the expectation is for back-ended growth.

In providing some color on guidance, management highlighted softness in both major vertical groups:

• Financial services, in banking more than insurance, where some of its banking clients are “taking a cautious approach”, putting some projects on hold
• Healthcare, where the major consolidation that is playing out in the payer industry means that some of its larger payer clients are delaying IT plans until their merger plans are clear.

In financial services Cognizant expects to see some level of growth, but given some current project delays in banking, says it is adopting a “wait and see” approach, and until then being conservative in its forecast

In contrast, in healthcare CEO Francisco D’Souza claims to be feeling “very, very good” about the pipeline of large deals Cognizant has for 2016, many of these leveraging TriZetto. The expectation is that healthcare will have a slow start in 2016, with strong growth from H2 and into 2017.

Indian financial and business media was more alarmed by Cognizant’s references to softness in the financial services industry. At one point D’Souza commented “our expectation is that we continue to grow faster than (the) industry… certainly others in the industry I think will probably have some of the same outcomes in financial services that we do”.

In a pointed response to this, TCS issued an investor alert on the Tuesday referring to its own performance in financial services in 2015, pointing out that revenues from the Banking and Financial Services industry vertical in CY 2015 grew by 15% in CC terms, compared with 13.5% CC growth for the company overall, and that, on an organic basis, TCS' CC revenue addition of $1.85bn in CY 15 was “the highest in the industry”. In an interview with India’s Economic Times, TCS CEO N Chandrasekaran claimed “we have not seen anything negative with any client” and that “for financial services as a whole, it is going to be an excellent year for us.”

So why does one major vendor call out softness in BFSI and another major vendor make such positive comments? Has one of them got it badly wrong? Well, clearly not: they are obviously talking to their clients! But a vendor can refer only to its own client base, and to the services they themselves are delivering to that client base. As an indicator of the differences this can mean, where TCS has been suffering headwinds in recent quarters in its insurance business because of its Diligenta BPO unit, for Cognizant, insurance has been the growth engine in its BFSI business recently.

Every vendor today is emphasizing its capabilities in various areas of digital - but it is in the discretionary spend of their clients’ budgets that some vendors are now feeling the pinch. Having a strong outsourcing business delivering recurring revenues is clearly advantageous – and we note that Cognizant’s outsourcing services businesses have been lagging its consulting and technology services businesses, delivering just 7.6% y/y growth this quarter.

This leads us to the other area of softness called out by Cognizant: its healthcare business, which includes payer, pharma, biotech and medical devices. Recent growth has been driven primarily by continued strength in life sciences (which we estimate accounts for about a third of its healthcare revenues) but it is the payer sector that Cognizant has placed its bets, looking to leverage TriZetto to build a BpaaS utility. Cognizant continues to highlight that it is in advanced stages of discussions for some very large deals, that current issues are related specifically to M&A activity, and that it expects some of these deals to close from the second half of this year. To an extent, the consolidation happening in the sector makes a platform-based BPO offering more attractive to buyers. But will Cognizant build a true utility with TriZetto? NelsonHall research shows that while healthcare payers may be amenable to a BpaaS model for some industry-specific activities, as in other sectors, appetite for a true utility service (i.e. a multi-tenant platform model) tends to be low.

Finally, the company continues to generate lots of cash, nearly $700m in Q4, and now has over $4.5bn in cash and equivalents. As well as share repurchase, we may well see further acquisition activity this year, which is, of course, one way of returning to “above industry average” topline growth. It is in the public domain that Cognizant has walked away from negotiations for Dell Services (essentially the former Perot Systems, which has a sizeable healthcare business) because of price. A few weeks ago, Cognizant announced its acquisition of KBACE Technologies; will we see another acquisition announcement in the next few months?

NelsonHall will be updating its Key Vendor Assessment of Cognizant in the next few weeks. This is the most comprehensive profile of Cognizant available on the market. For details, contact [email protected]