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Hughes Software: A recap

Sep 25, 2003

Among all Indian software companies that have borne the brunt of the slowdown in global technology spending, there is one company that has been relatively harder hit. We are talking about Hughes Software Services (HSS), and in this write-up, we would discuss as to what went wrong, how has HSS performed in the changed scenario, and what does the future hold for the company. The problem started way back in 1996, when the US government introduced its telecom bill that allowed new companies, in addition to the existing telecom service providers (also known as Independent Local Exchange Carriers (ILECs)), to provide local telecom services. These new companies were called Competitive Local Exchange Carriers (CLECs), and they were to lease lines from the ILECs to offer value-added services in the telecom segment. In return for these leased lines, the CLECs were liable to pay the ILECs around US$ 20 per line. Now the problem arose when this deregulation led to an incessant growth of companies ‘arising from nowhere’ to provide services in the high-technology telecom space.

As more and more of these companies (providing services in the high-technology telecom space) came into picture believing that the existing and new service providers would buy new technology from them, there was a sporadic growth in new technology offerings (like VoIP) that caused a sort of disruption in the existing business of telecom service providers, thus leading to their downfall. Also, a sudden surge in the number of technology providers led to broadband capacities being built up in such a quantum that caused a demand-supply mismatch, leading to prices falling rapidly.

Failing to generate much business, the CLECs were not even in a position to pay the ILECs the required US$ 20 per leased line. Over that, as the overall economic environment weakened, the sales cycle for technology providers (like Lucent and Cisco) and outsourcers like HSS lengthened and many projects were moved indefinitely to the future, thus causing greater troubles for companies in this space. Furthermore, telecom service providers across the globe invested heavily in 3G licenses, putting severe pressure on their balance sheets, thus denting their financial performance, and consequently leaving them with lesser resources to expend on developing new technologies. This further impacted the topline of companies like HSS.

Also for HSS, the problems lay (and still lies) in the fact that its clients traditionally have been OEMs (original equipment manufacturers) for the telecom industry (like Cisco, Nortel, Motorola, etc.). These clients, as mentioned above, had significantly ramped up capacity during the tech boom, and as a part of a secular slowdown in global technology spending, they, already having excess capacity, cut down their costs, thus impacting suppliers like HSS.

A look at HSS’ performance of the last nine quarters, as shown in the graph above, gives a clear indication of the pressure the company has been going through. However, while a clear picture regarding the revival of the global telecom industry has still not emerged, the current trend indicates a cautious return towards investments led by broadband services and adoption of mobile applications. Also, outsourcing is gaining prominence as clients (global telecom service providers and OEMs) are outsourcing their non-core R&D and maintenance activities to companies like HSS. As an example, HSS recently signed an outsourcing contract with Lucent to provide software development and maintenance support for the latter’s selected wireless products.

On the valuations front, at the current market price of Rs 372, the stock is trading at a P/E of 20x its FY04 earnings guidance (at 60% EPS growth). The telecom space where HSS provides its solutions has been, and continues to be, highly volatile. However, as a strategy of derisking its business model, the company has initiated steps into the BPO segment (where it entered in FY03) and has increased its focus on providing solutions to telecom service providers (who are exploring new revenue streams through value-added services).

How successful the company is in these endeavors would take some more time to get cleared. However, with a focus on continuously upgrading its offerings (through rational investments in R&D and creation of IPRs), the company is poised for better times ahead, given that the global spending on technology rises and improvement in the global telecom industry takes place. Till then, it should be a cautious wait and watch policy for investors.

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