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Hughes Software: De-risking

Mar 4, 2002

The second quarter of FY02 was perhaps one of the darkest quarters in the history of Hughes Software Systems (HSS). The company saw a sharp 59% (sequential) decline in revenues from products. The product revenues fell from Rs 170 m to Rs 70 m in a single quarter. This forced Hughes Software to re-think its business strategy. The company has decided to widen its services portfolio to include business support and technical services to diversify its risk along with its core traditional offerings of networking related software. The impact on the topline (in 2QFY02) was cushioned by growth in revenues from services to Hughes Network Systems (US), its parent company. Consequently, revenues declined by 15% in 2QFY02. For the quarter, the company earned 87% of its revenues from services, while revenues from products contributed 13%. However, 3QFY02 it was a different story altogether. Hughes’ product sales jumped by 98% sequentially and the topline as a result grew by 12%, one of the highest for the software sector.

Pressure on margins
(Rs m) 9mFY01 9mFY02 Change
Sales 1,365 1,769 29.6%
Operating Profit Margin (%) 33.8% 28.2%  
Profit after Tax/(Loss) 408 395 -3.2%
Net profit margin (%) 29.9% 22.3%  

According to Mr. Arun Kumar, President and Managing Director, Hughes Software, the volatility in product sales is due to two reasons. Firstly, there is intense competition from niche companies from US and Israel. Many of them like Radvision, are well-established names, while Hughes is just beginning to make its presence felt in the markets abroad. Secondly, the numbers for products business are small. Hence, even a few customers can cause huge swings. This should come down as the product business grows in size over the next few years.

However, on a more macro level the problems lies in the fact that Hughes Software’s clients traditionally have been OEM (original equipment manufacturers) for the telecommunications industry like Cisco, Motorola and Nortel. These companies are facing tough times as they had significantly ramped up capacity during the tech boom. With collapse of the IT spending bubble these companies have excess capacity. Therefore, these companies have cut down on costs to maintain margins. This has impacted suppliers like Hughes Software.

Product sales: Worst hit
(Rs m) 9mFY01 % Contribution 9mFY02 % Contribution
HNS Services 499 36.5% 751 42.4%
Non-HNS Services 481 35.2% 640 36.2%
Products 385 28.2% 379 21.4%
Total 1,365 100.0% 1,769 100.0%

Hughes is now looking beyond the OEM space and is trying to offer its services offerings to application service providers. The services providers are those who offer fixed or mobile telephone services like MTNL and BSNL in India. Hughes plans to provide services in both technical and commercial areas. While technical services would include management of network infrastructure and applications, the offerings in the commercial area is likely to include business support services. The company is currently focusing on billing and commercial applications apart from systems integration services. The other areas where Hughes plans to offer services includes operational support systems like technical helpdesk and bank end services.

Parental care

Thus, Hughes has slightly shifted its focus from purely technology related software to accommodate the integration of networking and communications software with business application software. This makes a lot of sense. A telecom service provider is just like any other company and therefore need software to look into day-to-day commercial and sales operations. However, details like service usage is available from the networking systems. Thus, a seamless integration between the business and the networking systems would not only help these companies improve operational efficiency but would also help in developing business intelligence. In future the application service providers look forward to understanding usage pattern much more in detail. They could easily get answers like what age group is making long distance calls? Companies like Hughes could extend their services in the future to implement business intelligence solutions.

At the current market price of Rs 317, the stock is trading at a P/E multiple of Rs 20x its 9mFY02 annualised earnings. While the management has been unable to manage expectations for FY02, the company has proved itself in a niche market that is very difficult to penetrate. The competition is relatively lower for the company from domestic companies. Therefore, Hughes stands to gain when the business environment for the telecom OEMs improves. Also, it is without doubt that the way we use communication technology today will rapidly change. The 3G services are already witnessing roll out in a number of geographies. This again could open host of opportunities for companies like Hughes. The question is not if but when will revenues show strong growth once again.

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