A Bull on IT Outsourcing: Sahm Adrangi Sees Opportunities for Offshore Developers

The business is lot different today than it was back in 2003 when they had that same operating margin target. It just doesn't really make any sense,

Sahm Adrangi, CIO and Founder of Kerrisdale Capital Management, is best known for his shorts, but the firm has recently begun advocating a different sort of investment: long holdings in fast-growing IT outsourcers.

For years, Adrangi has been long Cognizant Technology Solutions (CTSH), a blue chip in foreign outsourcing. Firms like Cognizant, or peers WiPro, Infosys or Tata Consultancy, specialize in hiring teams of software developers to assist Western companies with their IT work. Focusing often on Fortune 500 clients, these developers can oversee the large American and European companies’ IT infrastructure, assist with large-scale IT implementations and spearhead custom application development.

Adrangi has been long Cognizant since 2014, when the holding first appeared in his investment firm’s 13F. Cognizant’s prospects enjoyed a significant boost in 2016, when Elliot Management announced it had purchased $1.4bn of stock. Kerrisdale threw in its support in a tweet, writing “Excellent letter by Elliott on $CTSH, we own and agree. Improved margins, capital allocation -> multiple re-rating”. Elliot’s target is $90 a share, and Adrangi doesn’t disagree:

“That’s a really ambitious price target … but the path to getting there is a lot more straightforward,” Adrangi said. “The business is lot different today than it was back in 2003 when they had that same operating margin target. It just doesn’t really make any sense.”

Indeed, since Elliott’s letter, Cognizant has exceeded estimated earnings for the last four quarters, and most analysts are recommending a buy or hold. Interestingly, CTSH is one of multiple tech holdings that Kerrisdale has shared in common with Elliott – Adrangi’s most recent top holding is Gigamon, which Elliott owns 15% of. Last year, Adrangi also owned Elliott investments Lifelock and Mentor Graphics. In both cases, Elliott successfully pushed those companies to sell themselves. Given Kerrisdale’s home base in New York, the firm is able to leverage relationships within the hedge fund community to both source good investment ideas and also to distribute his own.

As for Cognizant, it’s not the only IT outsourcing firm Kerrisdale is long – an even larger position for his fund is its holding in Luxoft Holding, Inc., one of the biggest IT outsourcers in Eastern Europe.

Unlike some of its India-based peers, Luxoft and its base of Ukrainian, Russian, Polish and Romanian developers focus exclusively on higher end application development work, such as building customized client relationship management systems, designing automotive infotainment software and coding investment bank compliance programs. Luxoft’s stock has languished because of the company’s customer concentration – Deutsche Bank and UBS have comprised more than half of Luxoft’s revenue over the past few years, and are no longer growing.

Adrangi released a report on Luxoft last year, tweeting in October “sell-off in 2016 due to concerns around customer Deutsche Bank. But $LXFT expanded footprint within DB, UBS during prior fin crises” and “$LXFT growing rapidly outside top 5 accounts. Sales ex top 5 grew 56% in FY16. Customer concentration will dissipate.”

Those predictions haven’t proven true so far, and Luxoft currently hovers around 2-year lows, after reducing forward guidance in its last quarterly report. While Adrangi hasn’t yet raised a coinvestment fund for any of his IT outsourcing investments, as he did with his short on DISH last year, Kerrisdale’s 13Fs show these stocks as large holdings.

As a young startup having started with less than $1 million in assets under management in 2009, it’s no surprise that Kerrisdale is best known for its work on the short side – after all, there are few better ways to make a name for oneself in the stock market than by publicly announcing a short. Bill Ackman’s public spat with Carl Icahn on the short Herbalife, embodied by the clip from Scott Wapner’s Halftime Show, will go down as one of the most entertaining episodes of high finance. But being long stocks is oftentimes the better way of making money, and we’ll see if Kerrisdale’s call on IT outsourcers turns out to be as profitable as Adrangi hopes.

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