HCL Technologies’ IBM software products acquisition move: Is the company's growth strategy too aggressive?

The current boom in the US IT services market has not gone unnoticed by the top tier Indian technology companies and one is witnessing a spate of acquisitions by leading players like HCL Technologies and TCS, which are buying assets/companies located there.

The latest – HCL Technologies will acquire select IBM software products for an investment of nearly $1.78 billion (approximately Rs 12,460 crore) and this transaction is expected to close by mid-2019.

HCL Technologies, in its presentation, has highlighted that once this acquisition is complete, it would provide incremental annual revenues of approximately $650 million (nearly Rs 4,500 crore). HCL Technologies’ acquisition in the US is at nearly 2.7 times expected annual revenues.

Representational image. Reuters

Representational image. Reuters.

HCL Technologies had consolidated revenues from operations of Rs 28,738 crore for the first half of the current financial year. The existing company, HCL Technologies, excluding the latest acquisition, trades on the bourses at about 2.3 times annualising first half sales of FY19. Other leading Indian players like TCS currently trades at nearly 5.3 times annualising FY19 revenues, while it is 3.7 times for Infosys.

Also, the existing HCL Technologies had operating profit margins of 23.3 percent in the first half of the current financial year, a rise of 120 basis point year-on-year. HCL Technologies has highlighted EBITDA margins (operating margins) of over 50 percent from this overseas acquisition, in a bid to justify valuations of this deal.

Also, this US-based acquisition is expected to be earnings accretive going forward, HCL Technologies has highlighted.

Investor concerns

The HCL Technologies stock was down 5 percent to Rs 961 on Friday, and it is hovering just above its 52-week low of Rs 854 that was reached a year earlier. And that’s because investors are concerned that the above acquisition would weaken HCL Tech’s financial position in the short-term.

HCL Technologies in early October 2018 had also completed a buy-back of shares amounting to Rs 4,000 crore and the 36, 363, 636 shares bought back by the company were extinguished on 11 October, 2018.

The recent buy-back completed by HCL Technologies would have resulted in a reduction in its bank balance and other current assets, but details are sketchy since it was completed post the 30 September 2018 results and accompanying balance sheet data.

Meanwhile, the acquisition cost related to select IBM software products of nearly $ 1.78 billion (Rs 12,460 crore) would be funded largely through internal accruals along with $300 million (nearly Rs 2,100 crore) of debt. HCL Technologies had a finance cost of Rs 50 crore in the first half of the current financial year and this is expected to rise, once the acquisition is completed.

Nevertheless, HCL Technologies on a consolidated basis at the end of 30 September, 2018 had cash and cash equivalents of Rs 2,042 crore, and other bank balances of Rs 1,559 crore, and they are expected to be utilised to finance the acquisition announced. Other current assets of the company at the end of the first half of the current financial year include investments of Rs 2,949 crore and others amounting to Rs 4,838 crore.

Growth in IT spending

Gartner had recently forecast that global IT services expenditure would grow 4.6 percent y-o-y in calendar year 2019, slower than the growth expected during calendar year 2018, but it would nevertheless provide growth opportunities for players like TCS, Infosys and HCL Technologies, going forward. IT spending in the US has been strong over the past few quarters, given the earlier $1.5 trillion tax cuts announced by the American government.

HCL Technologies had also benefited from a revival in US IT spending and had earlier reported a 14.8 percent y-o-y growth in its consolidated net profit to Rs 2,534 crore in the September 2018 quarter. And HCL Technologies' announcement of acquisition of select IBM software products would complement the existing IT services offered by the company along with expanding its client base in the fast growth areas of IT security and e-commerce.

Earlier, TCS to take advantage of the fast growth opportunities in the segment for providing software and allied technology services for the banking, financial services and insurance industry had acquired select assets of US-based Bridgepoint Group. Financial details of Bridgepoint, in terms of sales and net profit are sketchy but it specialises in the booming retirement services segment in America.

A revival in US IT spending is providing growth opportunities for Indian technology companies, and investors are closely monitoring the financial implications.


Updated Date: Dec 07, 2018 18:49 PM

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