HCL’s mar­gins set to re­ceive a boost from the IBM deal

The Hindu Business Line - - IT & TELECOM - VENKATA­SUB­RA­MA­NIAN K

A decade af­ter it pur­chased UK-based Axon, HCL Tech­nolo­gies (HCL) has bought seven prod­ucts from global tech­nol­ogy ma­jor IBM. How­ever, per­cep­tion in some quar­ters that the deal is over­val­ued and con­cerns over the fact that the com­pany has to take on debt knocked the stock down by around 5 per cent in Fri­day’s trade.

The com­pany will pay about $1.8 bil­lion for the seven prod­ucts, with HCL hav­ing an on­go­ing IP part­ner­ship on five. About 48 per cent of the to­tal cash con­sid­er­a­tion is payable by mid-2019 and the bal­ance about a year later.

Ac­cord­ing to re­ports, HCL ex­pects an an­nual revenue run-rate of $650 mil­lion from the deal, though the amount is likely to be slightly lower in the first year due to tran­si­tion is­sues. Thus, the com­pany is pay­ing more than 2.7 times the ex­pected an­nual revenue from these prod­ucts as con­sid­er­a­tion, which some might think is ex­pen­sive. But mar­gins are likely to in­crease af­ter this deal.

HCL has in­di­cated that it would fund the deal by tak­ing $300 mil­lion in debt, mainly be­cause some of its funds are locked up in FDs and longterm bonds that it has cho­sen not to liq­ui­date.

The fresh debt should not be a ma­jor fi­nan­cial bur­den for the com­pany, as it has al­most $1.6 bil­lion in funds (as cash, FDs, avail­able-for-sale se­cu­ri­ties etc.) as of Septem­ber 2018 and bor­row­ings of $424 mil­lion. On the whole, even af­ter the full pay­ment is made over the next 12-18 months, HCL would have a com­fort­able net cash po­si­tion.

Mar­gin ac­cre­tive

The deal is ex­pected to aug­ment HCL’s Mode-3 (prod­ucts and plat­forms) of­fer­ings, which ac­counted for 11.9 per cent of rev­enues (Septem­ber 2018) and en­joy an EBIT mar­gin of 24.4 per cent, much higher than the firm’s over­all mar­gin of 19.5-20 per cent. The IBM prod­ucts re­port­edly en­joy bet­ter mar­gins than HCL’s other ser­vice lines. Over the next cou­ple of years, HCL’s EBIT mar­gins are likely to get a a boost from these prod­ucts.

Given that the com­pany man­aged to in­te­grate Axon well and drive growth, these new prod­ucts too are most likely to pro­vide syn­er­gies and scale for HCL.

The mar­kets may have over­re­acted be­cause of the per­cep­tion that HCL is over­pay­ing for IBM’s prod­ucts.

But given the growth tra­jec­tory of the com­pany – it is likely to record dou­ble-digit dol­lar revenue growth for FY19 – and the stock’s high val­u­a­tion com­fort, the neg­a­tiv­ity is likely to fade out quickly.

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