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Hughes Software: Reality bites

Sep 17, 2001

Hughes was the only software company that seemed confident of not succumbing to the slowdown. The company’s initial guidance for FY02E was a 60% growth in topline. However, the global economic reality seems to have taken a toll on the managements optimism. The company recently revised its revenues guidance for FY02 downwards. The company now expects a topline growth of 25% to 35% for FY02. While the growth in revenues from services to its parents Hughes Network Systems (HNS) has been growing at a steady pace, it has been the revenues from other clients and products have shown a swift growth. It is these growth rates that seem to have been affected. Earlier the management was expecting a 20% growth in revenues from HNS, a 75% growth in services to others and a 100% growth in product related sales. However, it seems now that the growth in the revenues from services to others will be more or less in line with that from HNS.

The biggest concern is the product sales. For 1QFY02, the product sales declined by 8% compared to 4QFY01. This might be a trend as in 1QFY01 the product sales had show a 12% drop compared to 4QFY00. But the concerns are that the product sales might continue to show a decline.

High margins: The product effect?
Particulars FY00 1QFY01 2QFY01 3QFY01 4QFY01 FY01 1QFY01
Revenues from HNS 54.0% 40.0% 37.0% 34.0% 34.0% 36.0% 36.0%
Revenues from others 26.0% 34.0% 34.0% 37.0% 36.0% 36.0% 37.0%
Products 20.0% 26.0% 29.0% 29.0% 30.0% 28.0% 27.0%
OPM 38.4% 31.2% 33.4% 35.7% 41.9% 36.3% 34.4%

Even if the company manages to earn as much as it did in the first quarter of FY02 (Rs 634 m) for the remaining three quarters, the growth in revenues over FY01 will be in the range of 28%. Therefore, the quarterly results that Hughes will post are likely to be flat. But considering the company has cut its estimates so drastically there is a possibility it might show sequential decline revenue for 2QFY02.

According to Mr. Arun Kumar, President & Managing Director, in the last 30-60 days, the global economic environment has weakened and communication companies worldwide continue to face tough times. This has lengthened the sales cycle for Hughes and many projects were being moved indefinitely to the future. The company is unclear about the turnaround in the sentiment, however, when it happens it has set for itself a target of 60% growth in topline.

The company has stated that the PAT growth would be in the range of 23% to 27% (mid twenties). There could be a pressure on the company’s margins due to a decline in contribution of products to the revenues. The company like others has started exercising stringent cost control and is reducing non-essential expenditure to maintain margins. Earlier the company had laid-off 80 employees, nearly 5 per cent of its total workforce. This, according to the company, had been done to beef up the right mix of senior and junior people and was not due to the tough times it was facing.

The best and the worst
(Rs m) FY01 FY02E FY02E
Growth 85% 25% 35%
Revenues 1,985 2,481 2,680
PAT growth 67% 23% 27%
Profit after tax 629 774 799
No of shares 16.7 16.7 16.7
FDEPS 37.7 46.3 47.8
P/E (x) 9.9 8.1 7.8

At the current market price of Rs 373 the stock is trading at a P/E multiple 8-9 times its FY02 estimated earnings. For a company that is exclusively focused on technology and spends one of the highest on R&D (11% to 12% of income) to build new technology the valuations are certainly attractive.

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