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Digital: Not enthusing - Views on News from Equitymaster
 
 
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  • Jun 9, 2003

    Digital: Not enthusing

    In a move towards strengthening its Indian operations, HP has announced a merger between HP Servicesí India Software Organization (HPS ISO) and Digital (previously Compaq owned). The combined business is likely to further strengthen HPís global delivery capabilities.

    Digital has a well-diversified revenue stream that spans across re-engineering, IT-infrastructure services, implementation services and systems engineering. Digital also enjoys the preferred supplier status with HPís Network and Systems Integration Services business unit. Digital, which reported a healthy 27% topline growth for FY03, has seen continuous increase in HP business. But the risk of high dependence on HP has been declining over the years, as can be seen from the graph. The companyís aim of derisking its business model has borne fruit as business from its non-HP clients grew by 72% in FY03, compared to 19% growth in business from HP.

    Following this merger, HP will see a rise in its equity stake in Digital from 50.6% to 73.2% (the stake will increase further to 76.2% when the preference shares held by HP are converted). Though there are significant synergies, it seems that the retail shareholder has taken it on the chin. An issue of 27.8 m new equity shares will hike HPís stake and result in dilution of Digitalís earnings, as the earnings per share will then fall. As such, the existing shareholders of the company stand to lose on this account. However, as a part of this transaction, the company intends to declare a special dividend not exceeding Rs 24 per share prior to the issue of equity to HP.

    The deal is likely to put Digital in an advantageous position, as the services business will get a big fillip (the key growth operation for HP globally). Digital is also likely to become a crucial point for HP Servicesí global delivery capabilities in India. The merger with HPS ISO, which is an established services operation for HP since 1998, will bring in greater technological competencies, resources, customers and global participation for Digital.

    The stock currently trades at Rs 500 implying a P/E multiple of 15.6x FY03 earnings. Considering the merger ratio, the stock is likely to take a beating on the bourses. There are also fears that the parent may delist Digital from the Indian stock market.

     

     

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