The Hindu Business Line : Axon offer may strain HCL Tech accounts

HCL Technologies’ ambition of expanding its enterprise application services has found expression in its £441 million offer for the Axon Group in the UK. But if the offer goes through, HCL Tech will be introducing debt and interest charges in its balance sheet, which hitherto featured negligible leverage. Media reports suggest that HCL Tech would borrow £400 million at 6.5 per cent to fund this deal. The rest is from internal accruals. HCL Tech had about Rs 2,460 crore of cash (around £290 million) as of June 2008.

The benefits from this deal for HCL Tech include an expansion of the European geography, increase in enterprise application service offerings and getting access to verticals such as oil and gas and Government clientele through Axon’s established practise. Axon has been a consulting and solutions implementation partner of SAP for the past 14 years. Axon’s strength in consulting and solutions implementation is evident from the fact that the company derives 19 and 69 per cent revenues respectively from these two services.

Enterprise application services, including package implementation and associated consulting services, command higher billing rates compared to traditional application development and maintenance services. This service contributes 11 per cent of HCL Tech’s revenues, the lowest among tier 1 IT players. The acquisition would therefore provide considerable scope for HCL Tech to ramp up on this count.

But acquiring a company with a relatively low margin has its own challenges. HCL Tech’s net profit margin of 14 per cent is already several rungs lower than frontline peers, while that of Axon is 10 per cent. It also remains to be seen how much of work can be offshored, as only that would enable a low-cost high-billing scenario, thus enabling margin expansion. But even this can happen only over a longer time frame.

Similar challenges in relation to the Axon acquisition apply to Infosys as well. But Infosys has about $2 billion in cash and equivalents, making it relatively easy for it to finance a possible deal.

Infosys derived $993 or 24 per cent of its 2007-08 revenues from consulting and package implementation services. Within this, 33 per cent was from SAP package implementation and related services.