HCL Tech: The new challenger

For the first time, the company delivered on margins, revenue growth & cash generation.

HCL Technologies has rarely managed to deliver stable quarter-on-quarter growth, improve margins and generate cash flows simultaneously. But, the company has changed the perception of analysts this quarter, with all three factors having grown in tandem. For starters, sequentially, revenues are up 5.8 per cent to $915 million. And year-on-year, revenues have grown 33.5 per cent. The company has improved margins by 130 basis points and net income to operating cash conversion is at 114 per cent.

Analysts attribute this to a couple of factors including HCL Tech’s subsidiary Axon, acquired in 2008 for $658 million. The acquisition took HCL into the top 10 SAP services players globally.

Pankaj Kapoor, director equity research, IT services, Standard Chartered Securities, says, every one percentage point increase in the margin of Axon adds 17 basis points to HCL Tech’s margin. This would help the company offset some of the margin pressure emanating from wage rise. Clearly, the acquisition is helping the company as discretionary IT spending is reviving.

Other factor that helped HCL Technologies overcome the issue of volatility in revenues is stabilising of large deals. Large deals, which help companies earn annuities, are not profitable in the first two-three years. The large deals that HCL signed a few years ago are now profitable for the company, so even as the company chases new deals, it has the cushion of older and more profitable deals. Almost 45 per cent of HCL’s revenue comes from such deals, which lends stability to quarterly revenue numbers. So even if the company signs new deals, which are margin dilutive, mature deals will neutralise the impact.

Unlike IT bellweather Infosys, HCL is seeing good traction in volumes, too. There is movement across the client bucket. From $1 million to 50 million, the company has added new clients in every category of business. This shows decent traction and the company’s aggression, believe analysts.

Clearly, deals are not drying up despite clients transitioning to the cloud. Over five years, some 980 deals worth $200 billion are coming up for renewal. Even if one discounts the deals by two-thirds in the Indian context, it still shows market potential of $45 billion.

Maintenance of legacy systems may be dying but it will continue for the next few years, till companies to alternative models. And HCL is present in upcoming businesses like application development and infrastructure management.