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Sunday, July 08, 2001













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Digital Equipment (India): Hold and avoid fresh exposures

Recommendation: Hold and avoid fresh exposures

Krishnan Thiagarajan

GIVEN the high client concentration levels, relatively high onsite exposure and the restructuring undertaken by its parent Compaq Corporation, US, in its operations, investors may avoid fresh investment exposures in Digital Equipment (India) for now.

This is notwithstanding the strong financial performance for 2000-01, the Compaq's support and patronage and the steady improvement in operating parameters that inspire confidence. At the current price of Rs 453, the stock is trading at a price earnings multiple of 27 times its per share earnings of Rs 16.59. Investors may contemplate fresh exposures in Digital after the announcement of the first quarter earnings.


At present, Digital draws its strength from the strong support and business relationship with its parent, Compaq. Digital derived 88 per cent of its revenues from Compaq and the balance from other clients. The business-wise break-up of 2000-01 revenues indicates that Digital derives 51 per cent of its revenues from eApplications (consisting of business applications, Microsoft business solutions, life cycle management, e-enabling of applications and application migration), 22 per cent from Systems Engineering (consisting of operating systems, storage management systems, embedded systems and VMS), 21 per cent from eInfrastructure (consisting of network management services, IT enabled services and SAP) and the remaining 6 per cent from Telecom. The company is currently developing a campus of around 7,50,000 sq ft to seat 4,000 employees. The first phase of construction of 2 lakh sq ft to seat 1,200 employees began in December 2000 and is slated to be complete this month.


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On the flip side, the high client concentration level continues to be a cause for concern. Digital has managed to bring down the contribution from its single largest client _ Compaq to 88 per cent in 2000-01 from 99 per cent in 1999-2000. It enhanced its business relationships by adding 10 new clients in the fourth quarter (including Unilever) and 30 clients during the year. Nevertheless, the high client concentration may be a cause for near-term worry given the recent restructuring undertaken by Compaq. Compaq has indicated that it is proposing to shift its focus from pure hardware to software and services and is keen on making an acquisition of a software services company this year. From Digital's viewpoint, this not only raises the risk of more work being done in-house by Compaq, but may also diminish the scope for leveraging the Compaq relationship to obtain referrals and leads for new business.

Second, the high proportion of onsite business accounting for 64 per cent of revenues in 2000-01 (up from 40 per cent in 1999-2000) may offer higher billing rates for Digital, but may also lead to an erosion in operating profit margins. The biggest challenge facing Digital is its ability to successfully shift a significant proportion of its onsite work offshore to provide stability to revenues and margins. This assumes even greater significance as it is making sizeable investments in offshore infrastructure and manpower this year.


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