The Hindu Business Line : HCL Technologies: Pare exposures

Mixed signals are emerging from the restructuring put through by HCL Technologies in 2001-02. While its acquisition strategy has worked well so far, the growth in its existing software business is yet to gather momentum, says Krishnan Thiagarajan .

Mr Shiv Nadar, Chairman, President and CEO

HCL Technologies is to unveil its earnings performance for the full year 2002-03 on September 12. Clearly, the stock performance boils down to a call on the turnaround of the US economic environment and resurgence of technology-related capital spending.

A slower-than-expected recovery in the US economy is likely to affect HCL Technologies' fundamentals in terms of the sluggish uptake of the application solutions segment and pricing pressures in its technology R&D and products/engineering business.

Shareholders can capitalise on the appreciation in stock price and firm trends in the run-up to earnings performance, to pare exposure in small lots.

Fresh exposures may be avoided till the earnings announcement is made on September 12. Based on the consolidated financial performance and management's call on the US economic recovery, investors may consider fresh investment positions.

In any case, it may be contemplated only at levels 15-20 per cent lower than the ruling market price.

The restructuring scorecard

Is the restructuring story of HCL Technologies, involving a flurry of acquisitions and joint ventures in 2001-02, panning out in line with growth expectations? For the consolidated HCL Technologies (including its subsidiaries and joint ventures), the inorganic growth model has worked quite well. Both its key acquisition/joint venture, Deutsche Software (addressing the banking and financial services space) and HCL Jones Apparel (the retail space) have turned in consistently good performance over the past three quarters of 2002-03. And this trend is expected to continue.

As expected, the growth of the BPO business is also encouraging. However, HCL Technologies' organic businesses have disappointed. The sequential (quarter-on-quarter) growth has been fluctuating over the past three quarters. This is largely attributed to the continuing client rationalisation and delays in project starts by new clients. On a consolidated basis, the company's operating margins are going down, but in a narrow range so far. Going by these trends, the future of HCL Technologies may hinge on managing three challenges:

Slow kick-off in applications: The quality of clients in the applications development/enterprise solutions segment has not staged a remarkable improvement over the past year. In the third quarter ended March 31, 2003, the contribution of application services was 35 per cent of consolidated revenues.

If this process of prolonged client rationalisation, slower starts among new clients and sluggish ramp-up of existing clients, continue, the growth of the company may be affected.

However, the company has claimed that the client rationalisation process is almost complete. It will be important to look for firm pointers from the management on the quality and growth of this segment in the fourth quarter performance to be announced on September 12.

Pricing pressures in technology: The biggest chunk of revenues of the consolidated company has come from Technology Development and Software Product Engineering Services. These two service offerings together contributed 46 per cent of revenues in the third quarter of 2002-03. Both ramp-ups in existing clients and new client additions in the avionics, semiconductor and embedded software has been fairly encouraging. But as these clients scale-up further, pricing pressures in the form of billing rate negotiations/re-negotiations will surface in the near term. This will have an impact on the operating profit margins (OPM) over the next year. On a consolidated basis, the OPM are trending downwards, but have been in a narrow band so far. Between the second and third quarter, the OPM fell by only one percentage point to 21 per cent. If these pricing pressures manifest, the margins may come down sharply.

Rupee appreciation: The appreciation in the value of the rupee may have an impact on the company's bottomline in the latest and coming quarters. The sensitivity of the rupee appreciation on the bottomline is likely to be fairly high for software companies and HCL Technologies is no exception. However, this may be neutralised by higher `other income' accruing from treasury operations depending on when they are accounted.

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