HCL's profit growth driven by inorganic growth

HCL Technologies, the leader in front end emerging technologies of Internet, e-commerce and networking services reported a YoY growth of 162% in its net profits to Rs 2.1 bn in FY00. The bottomline growth was propelled by more than 500% jump in the other income and significant reduction in the interest cost. However the company's topline increased at a slower rate of 28%.

The business model of the company differs from other software companies. The company intends to grow its bottomline through inorganic growth. For the purpose, the company has evolved a 'Technology Market Acquisition Strategy' to forge strategic partnerships with select technology funds. The company will offer technology start up kits to customers of these funds and will retain option of equity investment in these start ups. During the year the company has invested Rs 394 m ( 17% of its cash profits) in five technology funds having a combined corpus of $1-$1.5 bn. The revenues from this investments will start reflecting in its bottomline only after 1-2 years.

Internet and e-commerce revenues contributed 41% of total revenues, 34% came from technology development services and the balance from networking. The company's offshore work has increased to 63% of total revenues from 49% in FY99. Nevertheless the operating margins of the company are comparatively low due to 55% increase in the marketing expenses.

The company derives 71% of its revenues from North America and 72% repeat business from existing clients. Further revenues from top 5 customers account for 19% of total sales. In future the company plans to focus on the European and Asia Pacific market which has immense growth potential.

The stock gets a valuation of 69 times its FY00 earnings at a price of Rs 1,010. It has been observed that those IT companies which are at the high end of value chain with excellent clientele and marketing & distribution network commands a P/E in the range of 80-100 times. HCL is one of these software companies. Its future valuations will depend on its ability to successfully unlock the value of its investments which will enable it to double its profits every year.