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Hughes Software: Slowly but surely - Views on News from Equitymaster
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  • Feb 26, 2003

    Hughes Software: Slowly but surely

    Hughes Software (HSS) had a terrible start to 3QFY03. The company reported a 76% (YoY) decline in net profits and its revenues were lower by 25%. But this was not the first time that the company posted such a disappointing performance. In 2QFY02, the company had posted a 52% (YoY) drop in net profits. Undoubtedly results like these are enough to scare investors away. But we feel that there might be a case to consider the company as a possible investment. But only for that segment of retail investors, who are willing to consider stocks with a higher level of risks.

    Not for the weak hearted
    Growth (QoQ) FY01 1QFY02 2QFY02 3QFY02 4QFY02 FY02 1QFY03 2QFY03 3QFY03
    HNS Services 23.3% 8.3% 8.0% 12.0% -15.8% 38.1% -36.7% 2.8% 5.3%
    Non-HNS Services 156.1% 5.1% -6.3% -15.0% 0.0% 15.1% 12.4% 17.4% 9.0%
    Products 159.0% -8.0% -59.3% 98.0% 17.9% -2.8% -27.0% 5.5% 16.0%
    Total revenues 85.0% 2.3% -15.5% 12.0% -3.2% 18.3% -18.3% 9.9% 9.6%

    The investment arguments in favour of investing in the company is that HSS, with its unique set of offerings, is set to benefit significantly from the changes that will take place in the global telecommunications sector. The company provides software products and services for networks. This in the past has been its bane. As a result of its offerings, its client are exclusively from the technology and telecommunications verticals. These are the two industries that have been hurt the most due to the technology meltdown.

    Traditionally, the company has focused on providing services to equipment manufactures like Cisco, Erickson and Motorola. However, with telecom service providers (companies that buy products from equipment manufacturers) riddled with significant amount of debts and over capacity, it is unlikely that HSS will see revenues coming from the segment in the near future. To counter this, Hughes is now looking at the telecom service provider (TSP) segment for business. To survive the downturn and intense competition, TSPs will have to consider certain service offerings, which should translate into business for Hughes Software.

    Further the TSPs have traditionally billed customers based on time duration. As pattern of usage changes, the way customers are billed will have to undergo a sea change. This means over hauling and probably replacing, the operational support systems (OSS) / billing support systems (BSS) these companies use. With its significant understanding of the networks, the company is likely to be a strong contender in this segment. Another positive is that the company has significantly managed to dilute its revenues concentration from its parent HNS (Hughes Network Systems).

    HNS concentration: Diluting
    % Contribution of revenues FY01 1QFY02 2QFY02 3QFY02 4QFY02 FY02 1QFY03 2QFY03 3QFY03
    HNS Services 36.0% 36.0% 46.0% 46.0% 40.0% 42.0% 31.0% 29.0% 27.9%
    Non-HNS Services 36.0% 37.0% 41.0% 31.0% 32.0% 35.0% 44.0% 47.0% 46.7%
    Products 28.0% 27.0% 13.0% 23.0% 28.0% 23.0% 25.0% 24.0% 25.4%
    Operating Profit Margin 36.3% 34.4% 17.4% 31.4% 28.6% 28.3% 8.4% 19.4% 25.9%

    While there is tremendous opportunity for growth, the biggest concern is the low visibility in the company earnings. In 2QFY02, the company saw a steep 59% sequential decline in revenues from its products business and in 1QFY03 the company saw a significant 36% sequential dip in revenues from its parent Hughes Network Systems. Even the management has not been able to provide a proper bearing for the company revenues in FY02. The management had initially given topline guidance of 60% growth for FY02. Immediately after the September 11 events, the management lowered the guidance to 25% - 35% growth. It was very evident from the 1QFY02 numbers that 60% growth for the year was quite difficult to achieve. The management once again lowered its revenues guidance and the company finally closed FY02 with an 18% growth in topline. Thus, the visibility of the company's revenues is extremely low.

    At the current market price of Rs 151, the stock is trading at a P/E multiple of 14x its FY03E earnings. Therefore, from a long-term perspective (three years), the stock appears to be an attractive investment opportunity. However, considering past performance, the element of risk (due to volatility in earnings) is extremely high. We have updated our research report on the company with three years of forward financials to assist you in making your investment decision. (Research report)



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