HCL Technologies' growth strategy: Slow and steady wins the race

Last week, HCL Technologies became India’s third-largest information technology (IT) services entity by annual revenue. And, for this financial year, forecast revenue growth much higher than larger peers.

 Yet, the next day, its share price fell nearly 6 per cent. Reminescent of what had happened last December, when it had bought some IBM products for a whopping $1.8 billion, the stock fell 7.6 per cent. Sector watchers and investors were concerned about the IT major being able to integrate and sell those products, whose total addressable market HCL estimated at more than $50 billion. 

“Clearly, HCL has a different strategy from its peers and one the investor community is still trying to assess,” says Peter Bendor-Samuel, chief executive officer (CEO) at research firm Everest Group. 

Unlike its rivals, HCL has made a huge bet on selling products and platforms. It has acquired as many as nine companies since 2016. 

“HCL only acquires where it does not have capability. These decisions are based on what we are hearing from clients and they know they don’t have the capability in-house,” said a person who has worked closely with the HCL management.   

Moving up

Last Thursday, the Noida-based IT major said its revenue touched $8.63 billion in 2018-19, a rise of 10 per cent annually, toppling Wipro (revenue of $8.12 billion) from the third spot of IT firms in India and upsetting that ranking for the first time in seven years. 

“Management of concentration risk is being rigorously enforced by regulators in the more regulated industries, such as financial services. In spreading this concentration risk, HCL is increasingly becoming a favoured alternative to others such as IBM, Accenture or even TCS, where this concentration might lie for potential clients. As a result, HCL is increasingly picking up the business that would have gone to their larger peers or those perceived as having a stronger brand,” says Sanjoy Sen,  senior research fellow at Loughborough University, UK.

Growth targets

HCL forecast 14-16 per cent growth in revenue, with a margin expectation of  between 18.5 and 19.5 per cent for FY20, drawing a mixed response from analysts.

Of the overall revenue growth forecast, seven to nine per cent would be organic and the rest from acquisitions made last year, said HCL. In the past, it said, it expected the products from the IBM acquisition to add around $650 million in additional revenue by the current financial year.  

“The Street was quite disappointed with the lower margins guidance (forecast) for FY20. Investors also fear balance sheet risks, as the company plans to raise $200 mn for funding the seven IBM seven product acquisitions," said Sanjeev Hota, research head at Sharekhan.

Everest's Bendor-Samuel says there is no evidence to suggest the IBM deal isn't working; if so, it will take some time to become apparent. The negative sentiment against HCL is  compounded by "the belief that these acquisitions of IP(intellectual property) and companies will prove costly to integrate and this cost will suppress the margins. Having said all that, if HCL is correct in its assessment of long-term value in these assets and can manage the integration cost, we are likely to see the stock rebound as investors gain more confidence in the strategy", he added. 

“Considering the robust deal wins by HCL in previous quarters, we believe the organic guidance for FY20 is disappointing. This may be due to pressure in the legacy business," wrote Devang Bhatt and Deepti Tayal of ICICI Direct in a research note after the results were announced. 

They, however, noted that infrastructure services, 39 per cent of revenue, saw healthy growth (in the final quarter of 2018-19) on the back of deal ramp-ups, which is expected to continue.

Some were more positive about HCL’s growth forecast. “HCL has consistently performed well against its guidance and I expect it to continue its stellar performance,” said Hansa Iyengar, senior analyst at Ovum.

CEO effect

The company's CEO of a little over 30 months, C Vijayakumar or CVK as he is usually called, is known for execution and an eye for the future. Nanat Gupta, his predecessor, was known for having an eye for detail and numbers. 

Seven of the nine acquisitions made by HCL have been under CVK's watch. A career HCLite (he joined in 1994), he understands well its culture and ethos. “He understands technology, is good at talking to clients and wants to focus on what clients would need two years down the line. He is very focused on delivery,” said the person quoted earlier who has worked closely with HCL. 

HCL is managing to match Accenture’s performance by not being like Accenture, said Jamie Snowdon, chief data officer at HfS Research. Accenture, with 60 per cent of its revenue coming from digital services, continues to post good numbers, with much of its growth driven by digital and cloud services. Analysts said HCL's focus on cloud and its IP-driven product business in a way was putting the firm in good stead for future growth.   

 “HCL has focused more on delivering on the technology component of engagements and has been aggressive in taking on large deals against incumbents in the US and Europe...its better growth and stronger market share is evidence that its investment strategy has worked out long-term,” he added. 

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