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HCL Tech: Is it turning around? - Views on News from Equitymaster
 
 
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  • Mar 23, 2004

    HCL Tech: Is it turning around?

    HCL Technologies is one domestic software company that has not only borne the brunt of poor performances during the slowdown but has also suffered on account of its inorganic growth strategy going sour on a number of occasions. In this write-up, we would briefly discuss about the company's present situation and see where it is likely to be headed going forward.

    The company is the fifth-largest software exporter from the country and is focused on research and development (R&D) outsourcing. Its service offerings include technology development (25% of revenues), product-engineering (16%), networking (10%), application development (40%) and IT-enabled services (9%). HCL Tech's forte, traditionally, had been the R&D outsourcing and technology development spaces where the company suffered extensively owing to drastic reductions in global companies' R&D budget.

    This led the company to initiate a diversification strategy to focus more on other services like those mentioned above. In this regard, HCL Tech formed certain strategic alliances with foreign companies with competencies in specific fields. For instance, in late 2001, the company formed an alliance with British Telecom to provide contact centre services and strengthen its presence in the ITES space outside India. Then, in mid-2002, the company brought in stake in Aquila Technologies, a Bangalore based software solutions provider in areas of engineering services like CAD/CAE (computer aided designing/engineering) and PDM (product data management).

    This inorganic growth strategy was also used by HCL Tech to improve its competencies in certain verticals. For instance, in mid-2002, the company acquired Gulf Computers to strengthen its application development services, specifically in the government vertical. During this period, the company also formed a joint venture with Jones Apparel Group, US, in its bid of strengthening its presence in the fast growing retail vertical. Some of these initiatives have helped the company in garnering some major outsourcing contracts, like those from Airbus (for development of embedded software), AMD (for IT infrastructure management) and BT (for BPO services).

    Now, apart from growth in these abovementioned services streams, the company seems to be coming out of the slowdown in technology development services and this gives it a competitive edge over others, owing to the high-technology nature of the segment. Also, within this technology services space, HCL Tech has increased its presence in the high margin semiconductor industry that has usually not been the strength of Indian technology companies.

    Apart from the slowdown that had hit the entire software industry in the country, HCL Tech's poor performances in the past also bear testimony to its failure of a large number of its inorganic growth initiatives. As a matter of fact, at the end of FY03, the company had around 40 subsidiaries, 4 joint ventures and a couple of associates. This has affected HCL Tech's margins on account of difficulties arising from integration of acquired entities into a common culture and increasing costs of such acquisitions. Over that, the company seemed to have lost focus on its organic business (around 75% of revenues) that turned out a spate of poor performances till about a couple of quarters ago.

    At the current price of Rs 246, the stock is trading at a P/E multiple of 19.2x its 1HFY04 annualised earnings. While the company seems to have learned many a lessons from the past, as can be seen by its strategy of de-risking its revenue streams, the big concern of its inorganic growth strategy failing ‘consistently‘ to contribute constructively to growth would weigh heavy on investors mind. However, while the company seems to be tiding this over through growing its organic business, it is too early to judge whether this growth would attain some sustainability. In that case, investors need to maintain a cautious stance with respect to the stock.

     

     

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