HCL acquiring intellectual properties from IBM a risky bet, say experts

Industry experts are of the view that the company has taken a risky bet by investing in those IPs

HCL Technologies will acquire select intellectual properties (IPs) from global technology giant IBM in a deal valued at around $1.8 billion, making it the largest acquisition in the domestic IT services space.

The Shiv Nadar-owned IT major said it would buy nine IPs from IBM in areas like secure device management, marketing automation, omnichannel e-commerce, and digital experience. The all-cash deal, which is expected to be concluded by mid-2019, will largely be funded through internal accruals, along with a mix of $300 million in borrowing.

Of the $1.8 billion, around 50 per cent will be paid by the middle of next year, while the rest of the payout will happen over a period of 12 months following the closure of the deal, company executives said during an analyst call on Friday. 

At the end of the second quarter of 2018-19, HCL, the country’s fourth-largest IT services provider, had cash and cash equivalents of around $1.6 billion. HCL has already put in place an aggressive IP-led growth strategy, investing as much as $1.1 billion in buying product licences and IPs from companies like IBM and DXC Technology over the past couple of years. 

Through the current deal, the company will also be able to reach out to around 5,000-strong enterprise clients of IBM that are currently using these products. 

Such client base creates an opportunity for the firm to cross-sell its various offerings in the services space under Mode-1 & 2. Under the current arrangement, employees who are managing the sales of these IPs and platforms at IBM will now come on the rolls of HCL Tech.

“This will enhance our geographical reach along with creating a direct relationship with the customers. It also gives us the ability to take our services offerings to clients around these products,” said C Vijayakumar, president & CEO at HCL Technologies. “In terms of management bandwidth, we have built leadership for managing products and platforms within HCL. This is part of our long-term strategy,” he added.

The Noida-headquartered firm said it would receive incremental revenues of $650 million annually from 2021 onwards. Similarly, it sees operating margins from these products to be around 50 per cent after two years of closing the deal.

At this valuation, the HCL-IBM deal becomes the biggest investment made by any domestic IT services player in recent years. In 2009, Tech Mahindra had acquired the then scam-ridden Satyam Computer Services for $1.2 billion, while HCL Technologies had bought Axon Group for $731 million in 2011.

Despite positive management commentary, the deal failed to enthuse the market as the company’s stock fell close to 5 per cent to Rs 961.55 on Friday, when the benchmark Sensex closed 1.02 per cent higher. Industry experts and analysts also remained divided over the prospects of the deal.  

“HCL has been the canniest of the Indian majors over the last couple of years with its products strategy. It has scaled up its products business impressively, with revenues topping $1bn, of which 80 per cent is tied to IBM. Hence, this is a win-win for both firms,” said Phil Fersht, founder & CEO of HfS Research.

However, some analysts remained sceptical. “It is a bold strategic move by HCL but is a risky one for sure,” said Pareekh Jain, founder of Pareekh Consultant and analyst tracking the engineering services sector. “Globally, there are very few companies which are able to manage product and services business successfully. I think HCL has a strategy to spin off the product business as a separate entity in the future.”

  

Similarly, analysts are also of the opinion that the details on amortisation remain sketchy in the management commentary. “The critical amortisation aspect remains unanswered, leading to uncertainties on actual EPS (earnings per share) accretion,” said brokerage firm Edelweiss in a note.     

Harit Shah, senior analyst at Reliance Securities, flagged concerns regarding the growth profile of the product portfolio being acquired. “We are concerned regarding lack of clarity on key issues including the growth profile of acquired products. Some of these products are actually growing only in single digits,” he said in a note, adding that these IPs might not provide much revenue upside to HCL in coming years.