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Hughes Software: Growing despite pressure

Jul 16, 2003

Hughes Software Systems (HSS) has reported a strong 20% sequential growth in topline for 1QFY04. Also, the profits for the company have grown by 10% in the same period. This growth seems significant considering the fact that, globally, telecom software service providers are facing tough times. More importantly, the company has been able to improve upon its operating margins by 260 basis points.

(Rs m) 4QFY03 1QFY04 Change
Sales 637 765 20.1%
Other Income 28 18 -35.7%
Expenditure 482 559 16.0%
Operating Profit (EBDIT) 155 206 32.9%
Operating Profit Margin (%) 24.3% 26.9%  
Interest - -  
Depreciation 51 52 2.0%
Profit before Tax 132 172 30.3%
Extraordinary items 27 0  
Tax 21 20 -4.8%
Profit after Tax/(Loss) 138 152 10.1%
Net profit margin (%) 21.7% 19.9%  
No. of Shares 33.3 33.3  
Diluted Earnings per share* (Rs) 16.6 18.3  
P/E Ratio (x)   15  
* annualised      

Revenue growth was led by a 16% growth in telecom business (94% of 1QFY04 sales) and 144% increase in BPO revenues (6% of 1QFY04 sales). Higher volumes from existing customers (like Lucent, NEC and Nokia) and high utilization levels (93%) were the growth drivers. The company has added 14 new customers in 1QFY04. On the expenses front, staff cost as a percentage of revenues has gone up from 46% in 4QFY03 to 52% in 1QFY04. The rise in employee cost has to be viewed in light of general increase in salaries every year in the first quarter, addition of 78 employees in 1QFY04 and addition of 395 employees in 4QFY03. The significant addition in 4QFY03 includes 186 from Lucent, from which the company bagged an outsourcing deal in FY03.

While EBIT margins for the telecom business has fallen from 24% in 4QFY03 to 22% this quarter, that for the BPO venture has improved (though still negative) tremendously from –83% in 4QFY03 to –5% in 1QFY04.

While the overall telecom picture is yet to show some clarity, HSS has broadened its portfolio of service offerings. The company is increasing its initiative on the R&D front and has filed for 5 new applications for patents in this quarter. This take the total number of patent applications filed by the company to 17.

In continuation with previous quarters, revenues from Hughes Network Services (HSS’ principal shareholder and a unit of Hughes Electronics Corp., USA) are on the decline. This remains an area of concern.

Falling HNS revenues…
  1QFY03 2QFY03 3QFY03 4QFY03 1QFY04
Service-Others 44% 47% 46% 52% 58%
Service-HNS 31% 29% 28% 26% 22%
Products 25% 24% 25% 19% 14%
BPO 0% 0% 1% 3% 6%
Total 100% 100% 100% 100% 100%

During the quarter, HSS acquired Tenet, a Bangalore-based 3G and IP network software services company. Tenet has a significant sales and support presence in Japan, and this will enable HSS to leverage on these benefits to gain prominence in that country.

Another important news for HSS is that the News Corp has made an open offer for 20% stake in the company. This proposal is in line with a mandatory requirement of SEBI that requires an open offer to be made for an Indian listed company if its multinational parent undergoes any changes in management. It is to be noted that News Corp. had earlier made a successful bid for 35% controlling stake in HSS' US parent Hughes Electronics Corp. However, the effect that this deal is likely to have on the growth prospects of HSS still seems unclear. To that extent, the risk profile of the stock is on the higher side.

HSS has improved its revenue guidance for FY04 from 35%-40% to 55%-60%. Also profit guidance has been improved from 40%-50% to 60%-70%. At the current market price of Rs 279, the stock is trading at a P/E of 15x its FY04 earnings guidance (at 60% EPS growth). With technology changing rapidly, Hughes would have to invest in R&D on a continuous basis for developing new products. Also, the company’s growth going forward is highly dependent on the global economic recovery. Though the potential is promising, the risk profile of HSS is significantly higher due to poor earnings visibility. Retail investors have to keep this factor in mind before taking investment decisions.

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