Analyst corner: Maintain ‘buy’ on HCL Tech, target price Rs 1,330

Published: December 11, 2018 1:54:47 AM

Market has ignored HCLT’s potential to broaden its client base significantly.

HCLT has paid 4.9x EV/sales to acquire seven IBM products

By Elara Capital

HCL Technologies’ (HCLT IN) acquisition of seven products from US-based IBM has been met with such skepticism that market cap erosion was ~56% of $1.8 billionHCLT has agreed to pay towards the deal. We reiterate IP acquisitions would improve differentiation in large outsourcing deals and management commentary concurred in 1QFY19. We also believe the market has ignored HCLT’s potential to broaden its client base significantly.

HCLT has paid 4.9x EV/sales to acquire seven IBM products; even if we consider $3.2 billion as total purchase price (we assume all payouts in the past towards IP and increase in intangible assets over the past two years to be associated with products acquired). In a comparable deal, Broadcom paid 4.6x EV/sales to acquire Computer Associates with a sticky, but slow-growing, mainframe segment (51% of revenue at 65% margin) and a less competitive enterprise software segment (41% of revenue at 9% EBITDA margin) with the rest being professional services at 3% margin (part of which HCLT acquired earlier this past week from Broadcom).

Our channel checks underscores what HCLT management has said is its playbook for reviving products acquired, investing in clearing backlog of tickets to improve client satisfaction among installed base, investing in support for new technology, such as containerisation to improve value proposition of products, innovate with new technologies, such as AI and ML that can change the way products are used, and create a cross-sell with “as-a-service” model.

We had said end goal for HCLT’s IP investments are similar to former Infosys CEO Vishal Sikka’s vision (refer to portfolio in transition; FY19 to be slow; May 3 2018, and Investing for differentiation, August 3, 2016). We reiterate the plan looks more ambitious and HCLT could be looking to occupy a position vacated by HP and IBM, which had an end-to-end value proposition for enterprises straddling hardware, software and services. We reiterate ‘buy’ and revise our estimates for IBM products acquired. We arrive at a new TP of Rs 1,330 from Rs 1,360 on 15x (unchanged) FY20E P/E.

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