HCL Technologies: Hold

Recommendation: Hold

Krishnan Thiagarajan

IN A highly volatile market, the technology stocks have had an indifferent run since the Nasdaq meltdown in March-April 2000.

The frontline stocks have been no exception to this trend. However, the resilience displayed by the frontline stocks on every decline makes them a good investment vehicle for risk-preferring investors seeking exposure in technology. Given the strong financial performance of the frontline stocks for the first two quarters of 2000-01, the medium-term outlook for software service companies continues to remain strong.

HCL Technologies' strategic and consistent focus on five key operating parameters -- quality-revenue mix, earnings-led growth, focus on emerging technologies, non-linear growth model and concentration on a strong management team/employees has led to qualitative and strong growth in the company since its IPO in November 1999.

From an investment perspective, at the current market price of Rs 646 (post stock split), existing investors can stay invested for fair capital appreciation in the medium term. With HCL Technologies planning an ADR (American Depository Share) Offer of $500 million in one or more tranches, fresh investments may be contemplated after the SEC registration as it would provide a clearer idea of HCL Technologies future plans. The company recently approved a 2:1 stock split (sub-dividing each existing equity share of Rs 4 into two equity shares of Rs 2 each). The split came into effect this week.

Prospects and financials: HCL Technologies has succeeded by following a model of growth different from its frontline peers in the software services industry. Identifying client concentration and geographic concentration as the key impediments to growth once any company grows in size and scale, HCL Technologies grew by entering into a series of joint ventures and acquisitions between 1995 and 1997.

Basically starting with onsite software service opportunities, it set up nearly 15 subsidiaries spanning the UK, Germany, France, Sweden, Belgium, Japan, Hong Kong, Australia and New Zealand in 1997 and 1998. Using the strength of this onsite infrastructure, it consistently enhanced its presence in the outsourcing arena by setting up dedicated offshore development centres and related offshore facilities for clients over the next couple of years.

After notching up a good performance for the year ended June 30, 2000, HCL Technologies followed it up with a spectacular performance in the first quarter ended September 30, 2000.

On a consolidated basis (including its subsidiaries), HCL Technologies recorded a strong first quarter performance with gross revenue growth of 64 per cent to Rs 318 crore and post-tax earnings growth of 164 per cent to Rs 96 crore. Even on a stand-alone basis, the performance has been exceptionally strong, with a sales growth of 88 per cent to Rs 159.48 crore and a 166 per cent growth in post-tax earnings to Rs 89.69 crore for the quarter ended September 30, 2000.

The key features of its financial performance for the first quarter ended September 30, 2000, were:

*Contribution from high value-added services (technology development, software product and networking services) rose to 72 per cent of the total revenues in the first quarter ended September 30, 2000. This reinforces its focus on high margins in its software service business. In addition, the projects undertaken by the company in the first quarter reinforce its focus on front-end emerging technologies.

*The offshore-centric revenues at 60 per cent of the total revenues in the first quarter is a clear indication of HCL Technologies commitment and emphasis to shift and execute more work offshore. Even the billing rates for offshore-centric revenues are up 11.4 per cent in the first quarter. The operating and gross margins are also up fairly sharply in this quarter.

*Client concentration was well balanced with the Top 5, Top 10 and Top 20 customer contributions at 23 per cent, 35 per cent and 46 per cent of revenues respectively in the first quarter.

*Employing a non-linear growth model for the year ended June 30, 2000, HCL Technologies made investments in technology funds which were focussed on funding emerging technologies. Investments of Rs 39.4 crore in five strategic funds and equity investments of Rs 8.9 crore in Harmony Inc, US, towards R&D investments for the commercialisation of technologies.