This Turnaround Has Already Turned

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Investors apparently have high hopes for Computer Sciences Corp (NYSE: CSC); the stock has more than doubled since August and may head higher in the coming months.

Computer Sciences is in the early stages of a turnaround that is already showing signs of promise. The company brought a new management team on board in early 2012 and activist investor David Einhorn has expressed confidence in the company's turnaround.

The focus of the turnaround is on improving margins, which fell dramatically under the previous management team. Cutting costs and increasing operating efficiency is the perfect job for an activist investor, so I am confident that the company will eventually be able to earn $4 to $5 per share as the turnaround takes full effect.

Good business

Computer Sciences operates a good business with a fair amount of recurring revenue. It has an enormous backlog that is more than double its annual revenue -- this provides a high degree of revenue visibility for the company and investors.

Computer Science's business is dependent on two things: (1) its expertise and intellectual property, especially in healthcare and banking (2) its strong relationships with federal, state, and local governments, which provide a steady stream of new contracts. However, uncertainty in the healthcare sector and reductions in government spending could potentially derail the turnaround.

Another potential source derailment comes in the form of competition. Cognizant Technology Solutions (NASDAQ: CTSH) has maintained its margins despite a sharp increase in competition -- a feat Computer Sciences was unable to accomplish. In addition, Cognizant is growing its presence in the underserved European markets, which positions the company for a long runway of growth.

However, Cognizant and Computer Sciences both suffer from rivals poaching their employees; as poaching continues to heat up, the two companies may have to turn away business because they are unable to serve additional customers. But this is a cyclical issue more than a secular one.

A better option?

The turnaround at Computer Sciences is already showing signs of success. Unfortunately, the market has noticed. Einhorn has stated that he believes the company could one day earn $4 per share. This figure makes the stock look cheap where it traded in early August (low $20s), but the run-up to the mid-$40s per share takes away the "no-brainer" aspect of the investment.

Instead, a competitor looks more appealing at this point. Infosys (NYSE: INFY) is a well-run company that has a long history of profitability. It has maintained long-standing relationships with key clients and its operating structure allows it to earn much higher margins than Computer Sciences.

More importantly, however, is Infosys's strong free cash flow generation; it hardly requires any maintenance capital expenditures, which enables it to earn significant free cash flow. Infosys is a growing company that trades at just 13.5 times earnings -- a bargain when compared to Computer Science's 11 post-turnaround multiple. Investors would be wise to consider an investment in Infosys before Computer Sciences.

Bottom line

The allure of investing in turnarounds its to reap the enormous gains once the company starts to turn. Computer Sciences has already started to turn, and the gains have been reaped. The company still has a long way to go before it justifies a higher valuation, so investors should stick with buying value that exists today rather than value that may materialize in the future.

Ted Cooper has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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