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HCL Technologies: Hold

Krishnan Thiagarajan


Mr Shiv Nadar, Chairman, President and CEO, HCL Technologies... Hemmed in by the slowdown in IT spending, is he making the right call?

"HCL Technologies has weathered these challenging times well and efforts towards rebalancing the portfolio and repositioning the company to exploit emerging opportunities are underway. Investments made this year have provided us additional platforms of growth. Early signs augur well for the future.''

— Mr Shiv Nadar, Chairman, President and CEO, HCL Technologies, commenting on the financial performance for 2001-02.

AS Mr Shiv Nadar has pointed out, there are early signs of a rebound in the fortunes of HCL Technologies on the revenue front.

After three consecutive quarters of sequential decline in revenues, the core organic business of HCL Technologies has recorded the first sequential rise in its revenues of 5.65 per cent at Rs 308.29 crore in the fourth quarter (April to June) of 2001-02.

But following a sharp decline in `other income' (owing to the restructuring of the treasury investment portfolio) and a step-up in selling, general and administrative expenses, the sequential earnings after tax dipped sharply by around 25 per cent to Rs 89.48 crore.

There was also a sequential decline in the EBIDTA (earnings before interest, depreciation, tax and amortisation) margin by around 2 percentage points to 29 per cent in the fourth quarter.

On a consolidated basis, according to US GAAP, HCL Technologies recorded a revenue growth of 16 per cent to Rs 1,629.27 crore, earnings after tax growth (before sales incentive and provisions) of 4 per cent at Rs 462.79 crore and a decline in net income (after sales incentive and provisions) of 11 per cent at Rs 425.32 crore.

Restructuring signals

To examine the consolidated earnings performance for 2001-02 and topline growth in the fourth quarter, it may be imperative to put the year 2001-02 in perspective.

The year 2001-02 has turned out to be a turbulent and challenging year for HCL Technologies on both the operational and financial fronts.

Following a sharp downturn in the US economy starting in late 2000, capital spending towards technology by Fortune 500/Global 1000 majors was a big casualty.

As HCL Technologies was overexposed to the technology development domain, its overall growth strategy went for a toss. To counter this trend, , the senior management of HCL Technologies embarked on a restructuring in two stages:

  • Inorganic growth strategy: In 2001-02 first half, as the markets remained in a fluid state, especially post-September 11, HCL Technologies decided to reposition the company by undertaking a series of aggressive acquisitions, joint ventures (JV) and alliances, on the lines of its successful 50:50 JV with Perot Systems Inc. And this was literally kicked off by HCL Technologies' JV with Deutsche Bank AG.

    In end-September 2001, it entered into a JV by acquiring a 51 per cent equity stake in the holding company of Deutsche Software — Deutsche Bank's IT subsidiary in India.

    This JV provided HCL Technologies access to the banking and financial services domain, the largest end-user segment in the IT services space.

    In less than a year, the success of this JV can be gauged by the fact that Deutsche Software recorded a 17 per cent and 18 per cent sequential rise in revenues and earnings after tax in the fourth quarter of 2001-02.

    The company can acquire the remaining 49 per cent at the end of three years from Deutsche Bank.

    Following this JV deal, HCL Technologies went on an overdrive. Starting with the strategic alliance with British Telecom for providing IT enabled services, it has entered into a flurry of joint ventures, acquisitions and strategic investments over the next nine months.

    As of the year ended June 30, 2002, these non-linear initiatives have contributed around 11.4 per cent of the consolidated revenues of HCL Technologies.

    As HCL Technologies has the scope for acquiring the joint venture partners, the possibility of higher growth in the future is fairly good.

  • Organic growth strategy: In 2001-02 first half, as the technology space in the US and Europe was devastated, HCL Technologies seemed to meander without any defined focus.

    Then, it articulated a clear strategy to rebalance its services portfolio. In the analyst meet for the second quarter, Mr Shiv Nadar stated that HCL Technologies was in the process of rebalancing its service portfolio and has identified four focus areas of growth — Products and Engineering, Enterprise Solutions, Application Solutions and IT Enabled services.

    Since then, client rationalisations, clear domain focus spread across nine verticals, focus on enterprise and application solutions and strategic alliances in CRM, enterprise applications and enterprise application integration have provided the right organic thrust to HCL Technologies' revenues.

    In an encouraging trend, in the fourth quarter of 2001-02, end-user applications contributed to 28 per cent of revenues, reducing the emphasis on the technology domain.

    In addition, HCL Technologies has also used an indifferent financial year to enforce strict provisioning norms for accounts receivable and mark down its strategic investments in venture capital funds.

    In the consolidated income statement, for 2001-02, the company made a provision of Rs 61.2 crore towards these heads.

    Recommendation

    Though HCL Technologies has staged a rebound in the fourth quarter, the slower technology spending, pressure on billing rates, intense competition from its frontline peers and elongated decision cycles may contribute to sluggish financial growth in the coming quarters.

    To a large extent, investors may be better off waiting for the confirmation of a turnaround in the company's operations in the performance for the first quarter of 2002-03.

    Till the global economic picture improves, HCL Technologies is likely to perform only in line with the broad markets. In this backdrop, shareholders may retain their present holdings, but avoid fresh exposures in the stock.

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