Cigniti Technologies – Global Leader in Software Testing

Stock Opportunities Untested - but worth a good look
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Cigniti (CMP: 444, MCAP: 1133 Crore) is a Hyderabad based company founded in 1998 as Chakkilam Infotech & for about a decade the company was a me too company in crowded IT services market & didn’t went anywhere. The company changed its focus & strategy and repositioned to itself as an independent software testing Services Company around 2008. This repositioning was triggered by Promoter’s son returning from US after masters in computer science from US as they felt future lay in picking niche areas for growth.
It acquired Cigniti Inc (US based software testing and Services Company) in 2011 and rebranded itself as Cigniti Technologies. In 2013 it acquired Gallop Solutions Inc, a US based specialized software testing services company. Both these acquisitions gave it critical mass and strong foothold in US which is the biggest market globally.
Company vision is to become world’s largest and most respected independent software testing Services Company.
Software Testing Industry Overview
Around 20 to 30% of overall software effort is spent on testing and testing accounts for 20% to 25% of the total IT spend. The software testing services can be broadly categorized into two categories:
• Traditional Testing Services (TTS): The organization which develops software performs software testing. The person doing testing (business analyst or developer) are part of development organization and not full time tester.
• Specialized Testing services / Independent Testing services (STS): independent and specialist testers provide testing service
The industry trend is of shift in spending from TTS to STS because TTS is perceived to have conflict of interest (with SI doing both development and testing) whereas STS brings unbiased view, STS brings a difference in perspective & approach and need of specialized skill set for testing etc compared to TTS.
Globally, the market for Specialized Testing Services (STS) was valued at ~USD 15.7 billion in 2014 and represents 39% of totals testing spend while remaining 61% of spending is towards TTS. Nelson Hall has projected the STS spending to grow at a CAGR of 13% over 2014 to 2018While TTS is expected to degrow at -3% CAGR over same period and split of TTS and STS in the overall testing pie is expected to change to 52-48 by 2018.
As per NASSCOM outsourced software testing to India is expected to continue to grow at CAGR of 24% till 2020.

Company Highlights:
• Cigniti is ranked as challenger in the Gartner magic quadrant in 2015. Gartner is the leading and most respected analyst firm and it’s not easy to get into MQ.
• Cigniti is first STS company to be appraised at CMMI 1.3 Maturity level 3 in 2013 and became first STS company to be appraised at CMMI level 5 in 2015. CMMI5 is a significant achievement and shows maturity and robustness of processes with focus on continuous improvement
• Ranked as Leader in software testing NEAT charts of Nelson Hall
• Has got recognition from Forrester as well as Everest group
• Currently serving 40+ Global 2000 companies
• Predominantly US presence. Has made an entry in European, UK, Australia, APAC region by setting up offices and sales team in 2014 and 2015.
• Company is putting lot of effort on marketing and thought leadership as evident from participating in various forums, seminars, events, white paper, blogs, analyst recognitions etc.
• Has Global strategic partnerships with leading tool vendors across technology landscape
• Has built strength in verticals of BFSI, Airlines, Retail, Healthcare & Lifesciences and Technology
• Is making all the right noises and soundbytes on methodology side like Agile, Devops in testing, Automation, Robotics Testing, Tools etc. Testing CoE’s like Mobility, IoT, Big data, Cloud labs etc. Also it has set up various industry specific CoE’s to build domain knowledge and competency.
Competition:
• Each of the big SI (Accenture, Infosys, TCS< Cognizant etc.) have set up a separate Independent Validation Services (IVS) practice to ride on the trend of shift in testing towards STS, For each of them IVS practice revenue is approximately 1BUSD order of magnitude.
• Among the pure play STS companies, In 2013 Cigniti was ranked at 3rd position from Revenue perspective while Qualitest was 2nd & SQS group as 1st. My assessment is that based on FY16 numbers Cigniti should be moving to 2nd position and they have setup their goal to be the number one by 2018 & they seem to be on track for that.
Management:
• Promoters seems to be honest and capable having a vision and strategy to drive the execution. Haven’t come across anything against the promoters.
• Has a strong and professional management team in place
Financials:
• Topline has been growing at CAGR of 58% for last two years and has shown same growth rate for 9M period of FY16.
• Revenue is well diversified from client concentration perspective with top client contributing 5%, Top 5 contributing 19% and Top 10 contributing 29% of the revenue
• US contributed 91% of revenue, 2% from Europe, 2% from India and 5% from RoW for FY15
INR (Cr) FY13 FY14 FY15 9M FY16
Revenue 150.8 259.1 378.9 433.2
EBITDA 8.8 35.6 38.1 63,8
EBITDA % 6% 14% 10% 14.7%
PAT 5 25.5 25.4 36.3
PAT % 3% 10% 7% 8.4%
EPS 2.66 12.27 11.04 14.66
RoE 10.68% 31.23% 14.61%
• Promoters have brought additional capital into the company by issuing shares to themselves on preferential basis at premium of 208.4 in May 2014 and at 346 in Dec 2014
• The Annual reports are very detailed & informative and give very good overview of business, their positioning and strategy. The investor presentation and overall content on website is also good.
• Recognized as ‘Fastest Growing Company in Asia’ in Forbes Asia Best under a Billion Forum 2014.
Investment Thesis:
• Scorching Growth set to continue: The Company has set a target of 300MUSD in revenue for FY18. It has been growing at 58% CAGR for last three years and looks set to continue to grow at high rate for next few years as well and should be able to reach in vicinity of that target in FY18
• Margin Expansion: Current EBITDA margins are low and have fluctuated between 6 to 14% over last few years, Management has gone on record to say that once they achieve critical size of 100 MUSD (which they would achieve for FY16) then they would have crossed the inflection point and the margins would start improving going forward and EBITDA can reach 20% over time (for comparison, the equivalent peer SQS India BFSI reported EBITDA margin of 20.5% for FY16)… So far they have been in expansion and investment mode where they focused on growth and investment by sacrificing margins. Now having crossed nflection point of 100 MUSD I expect the margins to expand going forward, expansion of margins is evident in 9M’FY16 results as well. The expansion in EBITDA margin will have much more pronounced effect on bottom-line which should grow at much higher rate.
• Leadership Position: Set to achieve Global leadership position which should lead to visibility and re-rating and will drive additional business momentum
• Bigger contracts and more G2000 clients: So far company was mainly catering to small and medium enterprise clients with small contract and project size. But with all the ground work done to achieve the recognition & leadership position in last few years, it should get into bigger, longer term contract and should be able to make entry into many more Fortune 500 clients. The growth rate in fact could further accelerate if this trend plays out.
• Testing as services is less impacted by changes in technology trends: Testing process & scope is more or less same whether it is for mainframe, ERP or Digital etc. Testing services are less impacted due to technology trend changes compared to a typical IT services or Product Company so testing is a less risky business to be in as long as the company keeps on investing in tools, automation and building domain knowledge. It is a kind of equivalent of pick and shovel play for technology market.
• Peer Comparison: SQS India BFSI (comparable peer) has a MCAP/Sales ratio of 4.5 based on FY16 compared to 1.9 for Cigniti based on expected FY16 numbers. Though these companies are have different profiles in terms of growth rate (SQS growing in mid 20s compared to 60% CAGR for Cigniti), Return ratios (SQS has better return ratios compared to Cigniti), Dividend payout (SQS is paying good dividend compared to no dividend from Cigniti), size (Cigniti will have 100 MUSD of revenue compared to 40 MUSD of SQS for FY16, Cigniti will be 2.5 times the size of SQS from topline perspective). SQS has P/E ratio of 33 based on FY16 compared to 22 for Cigniti based on expected FY16 number, In my opinion Cigniti has scope of re-rating when looked in comparison to SQS.
Risks:
• No Dividend: Company has not been paying dividend, Dividends are the real thing for an investor. They have gone on record in AR that they are focusing on using retained earnings to propel sales effort and for inorganic acquisition which will maximize the shareholder return in long term and hence not paying dividend…
• Moat, IT services business has become commoditized and it’s a challenge to differentiate & to sustain stickiness with the client for most of IT services companies. As long as Cigniti ensures good project execution, cost competitiveness, focus on automation, thought leadership and building domain knowledge, invest in partnerships etc which they seem to be doing all, they should do ok.
• Employee attrition: Company seems to putting lot of effort and investment in employee engagement as well as in their training & skill upgradation. Some of the videos available on youtube are really cool.
• Hyderabad based company, But business looks good and real Liquidity: It’s a relatively illiquid stock so small amount of buying / selling can lead to bigger price movements.
• Balance Sheet risks: Analysing balance sheet is not my strength, so seek help from folks to analyse balance sheet and raise red flags.
Disclosure: Started tracking few months back, have entered recently with my avg price around CMP, less than 5% of portfolio, plan to increase portfolio allocation further as story plays out and conviction increases. No investment advice, the above note is for tracking the story.
Information sources:
• Investor presentation and Annual Reports, company website
• BT article on Cigniti in October 2015 issue:


• Moneycontrol interview (Jan 2015) – Unfortunately this gentlemen committed suicide

• Nelson Hall analyst visit note
http://research.nelson-hall.com/blogs/?avpage-views=blog&type=post&post_id=359
• Blog from Sai Chintala (he is SVP with Cigniti heading pre sales), some of his posts provide good peek and insights into happenings at Cigniti

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Some of my concern on the side of financials:
1.) Cash Flow position on Operating Activity is negative indicating cash burn by the company to expand business.
2.) Operating Profit and Net Profit Margin is too low compared to other software businesses.
3.) The company is generating more cash inflow from financing activities and Investing Activities are also too low.

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Being from IT Industry and having closely monitored Testing services, I would disagree with this statement. Testing is going to be disrupted in next 5 years especially as companies move to Agile mode of development. The new tester has to be pseudo developer / BA rolled into one.

Also dependence on independent testing firms like Cigniti is going to reduce as Testing will no longer would be an independent thing, it will be integrated into development.

Software testing services is a non niche, highly competitive industry so is likely to be valued like one

Disclosure - No investment

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Yes you are correct.

Roles of testers are going to change and they will be a part of development cycle end to end to ensure the stability of the product

Automation is also going to play a huge part

and if there are constant changes in the product, special testing team is going to be time consuming process

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agree with you on the points. The company has been in investment mode where they have sacrificed margins for growth and expansion as they have expanded from geographies other than US to Europe, APAC etc and also have expanded offshore facilities. Promoters have brought additional capital thru preferential issue in both FY14 and FY15 to finance these investments instead of the excessive Debt route.
The margins have improved in FY16 and have been consistent at quarterly level in FY16 so far. Management has said they will be able to improve and take operating margins to 20% over time once they cross 100 M threshold. Important point is how will margins pan out going forward and what will be the impact of improving margins on bottom-line.

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Have a different view on the above. Traditionally the testing has been done the way you suggested where testing is done by the business analyst (who has done the design & given specification) and by the Developer who has done the development. But what I have seen is more and more companies are moving towards bringing independent testers for testing as traditional testing done by analyst / developer is perceived to have conflict of interest where same person/organization is doing both the development and testing. while independent testing brings unbiased view. That is the reason the top Indian SI’s have been able to scale up their Independent testing practices to a size of 1BUSD+ over last few years with high growth rates .
Also the shift in trend towards independent testing is evident from the commentary coming from various analyst and advisory firms.

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I feel one issue is being missed in this excellent discussion. Most of the organisations go in for what is called UAT - User Acceptance Testing. That is, the customer itself tests the software using its in-house team. This is usually the IT team who coordinates with the vendor for deploying the software. This is from my limited experience in the various projects that I have been involved in my work place - I have myself been a part of the UAT teams when the software was to be used for our departments.

My gut feel is that independent testing would be for niche and complex software, which could be a limited market. Please correct me if I am wrong.

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Recent interview of Cignti’s CFO talking about 50% CAGR for next couple of years and operating margins expanding to 20%. Link below:

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Disastrous results… Impairment cost of 332 Cr… more than half the income!!!
http://corporates.bseindia.com/xml-data/corpfiling/AttachLive/854bf732-ce7d-46bd-8b31-583463aa94a1.pdf

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in a quarter company, went in to a negative worth company…:frowning:

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Rajesh singhvir has really given an exhaustive review of cigniti & testing market. In fact the contours of testing are changing with testing, Quality assurance, managed services solutions & management consultancy. The testing market is bound to grow manifold in coming years. Every software development & its updates need meticulous testing especially in view of security breaks. Now testing is carried out during software development as bundled testing or testing after software development or a combination of both. Also time lines can be compressed in Agile & Devops mode. Digitalization & data analytics, cloud computing & IOT, security surveillance has added new dimensions. Rajesh has given good reviews on cigniti & it has played out well except for impairment losses which took toll on this scrip. I have really enjoyed reading Rajesh review, but personally I have kept away from cigniti & have substantial investment for the long haul in Sqs Bfsi,which runs on asset light model, paying out good dividends. MNC status differentiate Sqs Bfsi from cigniti, as also the exclusive focus on Bfsi segment. Sqs parent has been delisted & taken over by ASsystem technologies SA France & Ardian France, who are seeking diversification into Bfsi segment. The delisted Sqs parent has 50 % revenue from non Bfsi sector like retail, pharma, automotive, aerospace etc while other 50 % comes from Bfsi of which 20 % is outsourced to Sqs Bfsi. Globally Sqs parent & Sqs India Bfsi works as a single unit under Sqs umbrella. Even in the most severe stressful period, of brexit, UK pound depreciation loss due to brexit, clients freezing & ramping down of projects, awaiting clarity on brexit rules, Sqs Bfsi posted EPS of ₹24, during the most stressful period, while doling out ₹ 24 dividend & paying DDT of 20.36 % from its reserves. Sqs Bfsi derives major revenues from Europe, UK, APAC, while revenue from USA is less than 10 %. Under new promoters, ASsystem, clear plan is envisaged to mine substantial revenue from USA in coming years, as US is world’s largest testing market with a share of 50 % in global markets. For discerning investors with patience & risk appetite, Sqs Bfsi can be a a potential 5 bagger from current levels.

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Cigniti has come out of ASM & is languishing at ₹360 levels. Hefty impairment loss Last year, was cruel, since shareholders have been denied dividends, since inception, citing cash requirement for growth. Currently Quarter EPS is around ₹18 & may post EPS of ₹60, for the full year. Management hinted at paying dividends in future, at concall, after wiping out impairment losses & becoming Zero debt. If all goes well, cigniti may post EPS of ₹100, in the coming 2 years. Management says that the software testing market is projected to grow to 550 billion USD dollars in coming 5 years & cigniti is confident of doing well in its 5 verticals of travel & transportation, Bfsi, retail & e commerce & bundled testing for IT SI firms.

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Hey, Is anyone still following Cigniti? Would love to get some updates and let me share what i have tracked so far -

-Management seem pretty confident and optimistic, since after covid the world is shifting a lot to Digital and hence a lot of software related growth are yet to come and with it comes the “testing” part of those software.(AR’20)
-Management has achieved its goal of becoming a Zero Net Debt company (AR’20)
-Further, all Previous Losses have been wiped out and the tax rate is now back to normal.(Q1FY21 Investor Presentation)
-Under the Revenue Section, Top 3 revenue Sectors are Travel (21%), Retail (19%) and Financial & Banking (19%). The management hinted to emphasize more on the Banking and Financial Industry but that personally i think that the concentration is pretty even so once everything is back to normal, i dont think this factor will affect revenue a lot.(Q1FY21 Investor Presentation)

  • Also, Revenue concentration from clients is very low and nicely Diversified with the top client contributing around 5% to the revenue, Top 5 - 19%, Top 10- 32% and TOp 20 - 47%. (Q1FY21 Investor Presentation)
  • One thing i have realized is that Geographic Segment wise, A huge 84% of revenue comes from North America but I think that is justified considering the fact that America houses Silicon Valley which houses world’s biggest IT firms and also a lot of clients of Cigniti like Walmart are based in USA. (Q1FY21 Investor Presentation)
    -And they have just tied up with BABB London for Crypto Currency testing and plan to grow in that area too considering the fact that Blockchain is the future and already a part of our day to day lives. (Oct1 2020 Media Announcement report from BSE website)

I guess the next 2-3 quarters will determine where the company stands and how it will fare in the global as well as Indian space.

Disc. Invested Token Amount to keep tracking. Planning to invest more once Q2-Q3 results come.

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I want to check with anyone following this company as to reasons why it wrote off assets in 2017 that resulted in negative networth for that year ?

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core promoters’ holding is too low at 24%. 12.42% held by Sapna Pennem (wife of ex-promoter) is still in the promoters but she wants to exit at some point - may be waiting for better valuation.

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2021 AR highlights
Annual Report 2021

Declared 25% maiden dividend

Won 67 new logos out of which 8 are fortune 500 companies.

Reduced concentration of revenue from travel and tourism from 27 % to 17 %

NelsonHall has testing, Quality Engineering and Continuous Testing Cigniti as a Niche player in its magic quadrant for application testing services, has mentioned that continuous testing services leveraging BlueSwan which ispowered by AI & ML help clients achieve business outcomes at speed.

Planning to introduce new segment ie consultancy in digital transformation.

Ganesh Ramamurthy joined as chief revenue officer.

Toyota motors select cigniti as strategic qlty engineering partner.

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A decent quarterly performance considering other IT sector performance. Will wait for their commentary and remain invested considering its niche space and growth prospects and current valuations.

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Cigniti seems to be well poised to grow faster from here. Aquisition of RoundSqr has opened up real opportunities to sell/win Digital transformation projects within their existing client base.
Valuation looks reasonable considering the margin guidance they gave (15-18%).

Disclosure: looking to invest

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6th March 2023 --Cigniti Technologies --CNBC interview with CFO K Venkatachary :

–Q4 as of now cautiously optimistic & Biz is looking good, going by the run-rate we are confidant of repeating the performance for the Qtr ahead and FY24 also looks very good with order book situation & kind of renewals that have taken place.

–9M revenue is 154 Mn$ and FY22 is at 164Mn$ which going by Qtrly run rate their is 25% growth. Out of 32 clients out of top 60 clients have given price increase & the range of price increase is 7 to 10%.

–This increase is affected from Jan23 and rest of the client are getting affected from 1st Apr’23 based on the renewal timings.

–Going further for the existing clients the scope for revision on price increase is very limited but its more to do with selling. In digital engineering as a segment was 6 to 7Mn in the FY22 yr but this year it will be 9% which is roughly 18Mn$ on the estimated no. of 200Mn$+

–We are giving big push to digital engineering and we are confidant that we will be 24% of contribution from this segment in FY24 which will also be high teen growth.

–Margins --Margins will be in our favour as it has increased from 9.5% in Q1 to 15% in Q3FY23. We are tgting north of 16%+ next year based on the current estimates and FY23 will end up on avg.14.3% but we will move up to 16%+ with digital engineering push and price increase coming for the full year & few composition mix wherein more offshore which will yield higher margins for us. Stability of labour will also contribute to this.

–2 yr back there was an ambitious tgt of 500Mn$ & current run rate is 200Mn$ , last yr we did a rejig of our strategy wherein organically we had kept a tgt that by 2028 we should be getting to about 650Mn$ but putting both inorganic + organic together we will look at 1Bn$ size , organically we are ambitious to reach 650Mn$ by 2028

–Retail segment contributes around 16% to the topline, we have estimated 16/17% but from the retail enhancement have not happened but we have not seen any pushback in terms of budget from the retail as a segment where we are operating with the cust. but we are cautious for the next 2 Qtrs for this segment. The further spends are not happening and ramp-ups in deals is not happening & deferred by a couple of Qtrs

–InOrganic plans ? --There is a separate team which reviews it and we are serious to acquire capabilities on the digital engineering side & we are evaluating and there is a fair amout of pipeline & as the board decides we will come back to the media on it.

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They had aggressive targets for 2018 in 2016 which did not end well because of impairment as seen in Fy17 annual report :

The Company has incurred substantially on development of software testing products and tools over the past few
years. The Company has been keeping a keen watch on developments and continuously assesses any potential
impairment of such tools/products. While the independent/pure play testing space has been growing aggressively,
the offerings by service providers need to be continuously modified to suit the market needs such as DevOps, Agile
and the like. Also, the independent/pure play testing market space has witnessed entry of several new independent
providers and disruptive changes like the advent of cloud-based offerings and using machine learning, artificial
intelligence etc. In light of these changes and the overall market outlook for our software products in the testing
space, the Company has carried out an impairment analysis of such products. Based on such analysis and in the
absence of estimates of future cash flows arising from the sale of product licenses for these tools the Company has
decided to fully impair such tool developments costs amounting ` 3,32,07,91,707/- on a conservative and prudent
basis in line with the requirements of the accounting standards. Further, as per the revised strategy the Company
shall not be carrying forward expenditures of such nature and will charge off the same in the year in which
it spent.

They are looking at 18% organic rev cagr - 200 to 650 by 2028
38% inorganic cagr - 200 to 1000 by 2028 (Million $)

Took a small entry recently. Two things to ponder:

  1. Can management come close to its aggressive goals this time ?
  2. Quality of Inorganic Acquisition - The subsequent goodwill - Impairment if they pay a premium

Kindly share if you have tracked in depth. Any research report would be much appreciated

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