Well placed on the value chain
Rajiv Goel & Neena Puri

09/25/2000
The Economic Times
Copyright (C) 2000 The Economic Times; Source: World Reporter (TM)

HCL Technologies is the second largest software exporter from India and has developed expertise in high growth technology areas such as embedded software, telecom, networking, internet services, IT consulting and engineering product development.

HCLT has significant presence in segments at the top of the value chain and its revenue per employee is among the highest in the country. Among the few Indian firms with presence in technology development and network services, it is expected to capitalise on these services.

HCLT encompasses as many as 15 subsidiaries spread across the world, aimed at procuring software projects and development work for the parent. This helps in optimising offshore revenues for boosting margins, in direct interface with the clients through subsidiaries.

The company has 12 offshore development facilities in 3 cities - Noida, Gurgaon and Chennai. Of these, 7 centers are dedicated to doing development work in emerging technologies and 5 in applications engineering and development work.

For its high value clients, the company had 21 dedicated centers as of June 2000. This model has helped offshore business grow to nearly 63 per cent of sales, helping contain risks in onshore business and improving operating margins.

FOR delivering composite solutions in both internet/e-commerce and enterprise wide, HCLT has a four pronged service package.

Technology Development Services is targeted at hardware product companies, focuses on software components that are either embedded into or are integral to the functioning of hardware products.

Some areas of recent thrust are Digital Signal Processing for developing embedded software modules for next generation multimedia cell phones, technology for remote management of network, core solutions for Internet-based technologies, including commerce security, e-business applications and transaction based services, among many others.

In Netcentric business, the company emphasises in honing its expertise in underlying technologies for the infrastructure on which different e-commerce applications are built. Its clientele for this service includes Hewlett Packard, Priceline, VDO Mannesmann, GTech, etc.

Revenues from this segment contributed 34 per cent to the total. Contribution per man hour from this segment is twice that from software services. Thus, the emphasis on growth. It is one of the few IT companies spending a good amount on R&D, approximately 3 per cent of revenue, which is written off from the books. Growth in convergence of technologies will ensure growth of these services.

In the Networking segment, HCLT renders consulting and planning services right from the concept stage to design, implementation, integration and migration of multi-vendor, multi-technology networks for the large end-user organisations.

Its clients include Hewlett Packard, Mico Bosch, J&J. This segment contributed 16 per cent to turnover, an increase from 16 per cent in the previous year.

Down the value chain is software engineering services, which broadly encompasses IT consulting to end-users in large and medium-sized businesses with clients including Samsung, General Motors, NTT Data and Rockwell.

It contributed 18 per cent to the turnover, down from 46 per cent in the previous fiscal.

Application development services is targeted at software product companies which includes web-enablement, design and development of new application products, re-development and re-engineering and maintenance of existing products, global implementation and rollout support.

The companys key customers in this line of business include Priceline.com , Broadvision and KLA Tencor among others. The revenue share from this division has increased to 32 per cent against 23 per cent in the previous financial.

REVENUES have grown at a CAGR of 22.5 per cent over the last 3 years, with profits at the net level registering a 78 per cent growth. The offshore-centric business moved upto 63 per cent of revenues in financial 2000 from 49 per cent last year, thus improving the margins substantially.

In comparison with Infosys and Satyam which have average operating profit margins of 44 and 36 per cent respectively, HCLT's OPM is well below at 23.3 per cent.

The company's revenue mix tilted in favour of Netcentric business with its contribution to revenues touching 41 per cent in financial 2000 compared to 27 per cent last fiscal.

The effort to reduce client concentration reflected in HCLT acquiring the distinction of having the highest number of active clients in the industry at 269 as of June 2000, up by 76 over the last year. At the same time, repeat business from existing clients grew to 72 per cent in 1999-00 as compared to 64 per cent last year.

The company inducted 1167 professionals during financial 2000 with its manpower strength rising to 3701. Of this, technical billable manpower accounted for 3087 employees of which 3004 are based in India, reducing the deployment costs for employees sent abroad.

The company's marketing thrust is also strong with a 180-member marketing set-up. Average revenue per employee climbed to Rs 30 lakh in 2000 from Rs 24 lakh last year. The attrition rate stood at 22 per cent in financial 2000 due to high turnaround in less than the 1-year category personnel.

HCLT claims to have an attrition rate of about 7 per cent if the less than 1-year cadre is excluded. This rate shall be well below the 9 per cent attrition level of Infosys.

HCLT has grown through various alliances and partnerships to enter new geographies and access new client base. Its the 50:50 joint venture with Perot Systems, USA, to form HCL Perot which has helped it penetrate the European and US markets with solutions in the application engineering area.

Another strategy the company has used is to grant options to 13 clients including US based KLA Tencor and GTech Corporation. The company has entered into an agreement with a validity of 5 years beginning January 2000 with 13 existing clients.

During this period, on giving a specific amount of business to HCLT, they will be granted options of the company, which will get exercisable at the expiry of 5 years from the date of contract. As a result, after expiry of the 10-year period, a maximum dilution of 4 per cent can take place. Based on this agreement, the company is targeting $380 million, spread over five years.

The company is seeking approval for an ADR issue of upto $500 million. But it is yet to appoint even the investment bankers. With the company actively scouting for acquisition candidates abroad as well as domestically, SEC filing may take some time.

The US listing can be expected only after the fourth quarter current fiscal. The ADR issue is aimed at ensuring a currency for acquisitions and provide dollar denominated stock options to between 600 and 700 staff based abroad.

Around $300 million in cash residing in balance sheet as investments in debt funds is also intended to be used for domestic acquisitions. HCLT would largely be looking at listed companies as integration with the financials of the acquirer is faster.

The companies being acquired are intended to have technology, network services orientation and a quality client base.

A high degree of focus is being put on expansion through inorganic route. While acquisitions are one area, another mode is forging alliances with 5 technology funds with a combined corpus of $1-1.5 billion, the focus of which is on funding emerging technologies.

HCLT has already invested Rs 39.4 crore in last quarter fiscal 2000 in such funds with the aim of obtaining "client referrals" as well as retaining the option of equity investments in those companies.

The organic growth strategy is aimed at accelerating contribution of offshore revenue to boost its operating margins. An amount of Rs 125 crore is earmarked to enhance its development facility domestically.

IN the current fiscal, the share of technology development services in total revenue is expected to grow from 34 per cent to 38 per cent while that of network services is expected to grow from 16 per cent to 18 per cent. This growth would be achieved at the expense of application development services.

With average billing rates of $6500 per man month for financial 2000 and assuming billing rates of $6400 per man month, revenue works out to Rs 1412 crore, assuming a translation rate of Rs 45/USD. The company has cash balances of over Rs 900 crore in its balance sheet.

Assuming no inorganic growth takes place, this amount would easily fetch returns in excess of Rs 90 crore. Acquisitions may help improve the ROCE and consequently the returns. The bottomline is expected to witness a growth of 60 per cent, net of other income.

The scrip gets poor discounting compared to its peers on account of lack of FII interest. One of the reasons is poor liquidity in the stock as well as being among the top 5 capitalised stocks in the country.

The HCL name which was signified by poor corporate governance, has impacted sentiments, which the management has tried to redress by forming an independent board. The stock is expected to come into Group A and indices of BSE and of other exchanges as well as MSCI by the year-end.

These developments will shore up liquidity. A stock split is envisaged by bringing the face value to Rs 2 from the current Rs 4 per share.

Promoter Shiv Nadar holds 73.14 per cent equity stake while domestic and foreign institutions hold 6.71 per cent, Overseas Corporate Bodiess & NRIs 2.01 per cent and individuals and companies 17.87 per cent. ESOPs cover 93 per cent of employees, which will get vested beginning fiscal 2001.

The stock has potential for re-rating following its inclusion in the market indices. A lot would depend on FIIs investing in the stock, which again would be a function of the stocks visibility in the market.

Currently, FII holdings in the stock is quite low. One could invest with a medium term perspective. Key factor to be watched would be whether institutional investors embrace the stock.