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Hughes Software: Searching its way out…

Oct 14, 2003

Hughes Software Systems (HSS), India’s leading communications software provider, recently announced its September quarter results, where the company’s management has revised upwards its FY04 earnings guidance to 80%, a third revision in as many quarters. While the company is very well poised to meet this guidance for FY04, or even surpass it, let us take a long-term view on the prospects of HSS.

After bearing the brunt of slowdown in the global telecommunications industry, HSS has displayed improved performance over the last few quarters (see the graph above). However, this is not to neglect the volatility that the company’s financial performance has showed over the past few quarters (ten, to be precise). Even going forward, the niche where HSS operates would make its financial performance extremely susceptive to unpredictable changes in the global telecommunication markets, which in itself is likely to be encircled in increased levels of volatility.

Another concern for HSS is the declining revenues from its largest market, the US (55% contribution to total revenues in FY03, down from 71% in FY02). This is because of the fact that it is the US market where the genesis of the telecom slowdown lies, and that telecom players in this region have been the worst affected due to the same. One of HSS’ biggest clients, Lucent, which recently gave HSS a US$ 30 m three-year contract for software development and maintenance, is itself under tremendous pressure. Also, before any clarity regarding improving prospects of the global telecom sector emerges, times are bound to be tough for HSS.

While every cloud has a silver lining, even this one is not devoid of the same. In these times, when HSS’ largest clients are under tremendous pressure, HSS has gained from this in form of increased outsourcing opportunities. The very fact that HSS can provide its clients with quality offerings at relatively lesser costs has helped the company to garner outsourcing contracts from its clients who have been on a cost-rationalisation drive in response to the slowdown in the telecom industry. The contract from Lucent stands as an example. Also, HSS has initiated expanding into newer territories (like BPO and telecom service providers) and we expect these services to contribute increasingly to the company’s growth going forward. Another initiative by HSS is to continuously increase contribution from its non-HNS clients, when contribution from HNS is on a constant decline. While non-HNS clients contribute to around 50%-55% of HSS’ revenues at the present, we believe this figure to reach around 70% by FY06.

At the current price of Rs 404, the stock is trading at a P/E multiple of 18x our estimated FY04 earnings. With the telecom sector undergoing deep structural changes at present, a greater clarity regarding HSS’ prospects is yet to emerge. However, the company seems to be doing right by investing in R&D initiatives (13.5% of revenues in FY03) and new service offerings. This is likely to stand in good stead for the company as and when the global telecom sector revives. However, till the picture becomes clearer, investors need to practice caution.

Read our research report on Hughes Software.

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