Hughes Software: Buy on declines

Krishnan Thiagarajan

RECOMMENDATION: In contrast to the sharp surge in the tech stocks in the first quarter of this year, the tech sector as a whole, including frontline IT majors have suffered on an average 30-70 per cent decline in values since then.

As a fundamentally sound frontline stock, Hughes Software has also suffered a decline of 40 per cent, effectively being placed at the lower end of the decline cycle. Over the past month, the stock price of Hughes Software has stabilised within a narrow band of Rs. 2,600-3,200.

At the current market price of Rs. 2,868, the stock trades at a price earnings multiple of 153 times per share earnings of Rs. 18.72 in 1999-2000. Although the PE multiple appears fairly stiff, the sound fundamentals of Hughes Software justify the current valuation. Considering the long-term potential of the communication industry, the strong affiliation to its parent, Hughes Network Systems (HNS), expertise in communication technologies and a string of product and service offerings, Hughes Software has the potential to offer value to shareholders from a medium term perspective. Since a further decline in the broad market cannot be ruled out, investors can capitalise on every decline to build exposures in the stock.

Click here for Chart

cf303>SUITABILITY: As one of the major telecom software plays in the country, Hughes Software is poised to reap the full benefits of the growing integration between the information technology and the telecom sector. As `convergence' becomes the dominant theme in the IT sector, Hughes Software represents a good opportunity for investors to diversify their investments across a few top quality IT stocks. Although the risks associated with investments in the IT sector are high, the scope for growth of the telecom software sector makes Hughes a decent pick for the medium term.

PROSPECTS: With Hughes Software proposing a stock split in the ratio of 2:1, subject to shareholder approval, the stock price is expected to rule firm in the near term. The company has three main streams of revenues. The first one is outsourcing work for its parent, HNS - a unit of the $ 6.4-billion Hughes Electronics Corporation. This work accounted for nearly 54 per cent for 1999-2000, down from around 73 per cent in the previous year. In the fourth quarter, this contribution was down to 42 per cent. Over the last few quarters, the contribution from non-HNS outsourcing work has been steadily increasing which is good from the long-term perspective.

Second, its product portfolio which contributed around 20 per cent of the total revenues in the first half of 1999-2000 leaped to 31 per cent in the fourth quarter. It accounted for 20 per cent of the total revenues in 1999-2000. With atleast three major products - ProtoQuick, IntelliQuick and MultiQuick in its portfolio, future contribution from products division may continue to be strong. The increased contribution of the products division appears to have helped Hughes maintain its operating profit margins at 38.4 per cent in 1999-2000 vis-a-vis the previous year. This is also expected to be the core activity of the company in the near future.

Third, Hughes Software has established a dedicated internet and e-commerce development centre at Bangalore to mainly target the high growth e-commerce solutions and applications market. The revenues from internet/e-commerce business contributed 14.7 per cent of revenues in the fourth quarter. This stream of revenues are likely to strengthen in the coming years.