HCL playing the game differently

(By Anthony Miller). If there is anything positive to come out of the Satyam saga it is the increased levels of financial transparency from other Indian players, none more so than HCL. In what I can only call a ‘full and frank disclosure’ on Friday’s greatly extended 2Q09 results concall, HCL management drilled so far down the numbers they could have struck oil. This included giving the names of every financial services institution around the world where they have deposited cash and bonds and how much is with each (it totals $270m by the way).

After HCL chairman Shiv Nadar explained the extra governance measures the company is adopting, CEO Vineet Nayar went through in unusually high detail (but alas not with customer names) some of the major deals HCL won last quarter which contributed towards the record $1bn in new orders. The largest contract ($350m/7 years) was with a ‘worldwide publishing company’ for a major Oracle project including infrastructure management (IM), won against an Indian incumbent. But perhaps more intriguing was a $100m/6 year deal with a copier manufacturer (who shall remain Xerox) ousting EDS, which Nadar tactfully described as a ‘hostile transition’. A $145m/5 year deal with a phone manufacturer (also a hostile transition) was won against global majors and included remote desktop management. Indeed, 64% of the H1 deals that HCL won were against global majors.

I asked Nayar about progress with Axon and Liberata Financial Services (LFS), in particular, how much business they had won (or lost) since the companies were acquired, how much existing work had been moved offshore, and whether they had seen any rise in attrition. The answers were illuminating.

First Axon. Since the acquisition, the new HCL-AXON business, which now runs all of HCL’s SAP work, has won four new deals and they have not lost a single client. No Axon work has moved offshore – as is apparently the strategy. However, they won a new SAP ADM contract with an existing client which will have a significant offshore component – again part of the strategy. As for attrition, it seems there is none, at least at middle and upper management levels. Axon contributed $18m (two weeks) to HCL’s 2Q09 revenues, but this is expected to rise to $95m (say £70m) in the current quarter. The last firm sighting I can find of Axon’s numbers pre-HCL was for 1H08 (6 months), where revenues were £128m, so it looks like the business is growing, though there may be an FX effect here.

I must say I have been sceptical whether HCL could make this acquisition work. It’s still early days, but so far, so good. However, the Axon acquisition did knock 70bps off HCL’s margins, which will rise to 100bps in the current quarter. Mind you, whether HCL will go forward to “dominate the SAP space globally”, as Naya modestly predicted, is moot.

HCL is breaking ranks with Indian peers (and most of the other ‘onshore’ SIs) creating in effect a semi-autonomous SAP business, rather than presenting itself to market as a fully integrated, end-to-end IT/BPO services player. There again, HCL goes to market with its IM services under the HCL-Comnet brand, not well known to many, and to be fair IM has turned out be one of HCL’s strongest suits, accounting for 16% of total revenues.

Despite the downturn, perhaps the Axon acquisition will turn out to be prescient timing given the uncertainty over Satyam’s future. Satyam had the highest proportion of business from EAS (enterprise application services) than any other Indian player (45% of total revenues) and its customers will surely at least be looking at contingency arrangements. Before Axon, HCL was the weakest in EAS among the Indian SIs (11% of revenues) – and getting weaker. Now HCL-Axon is now ‘out there’ with what could look a very attractive offer, at least in the UK and US – a premium onshore front-end with an established Indian back-end. Let’s see if it lives up to the promise.

LFS is a somewhat different kettle of fish. No new deals won, but no clients lost. Attrition probably in single digits. No work transferred offshore. Nayar explained that HCL is still trying to get to grips with the LFS processing platform which needs modification, as does the (go to market) offering. LFS, which was acquired in July ’08 (see here), contributed a little under $13m (say £9m) to HCL’s revenues in the quarter and is still pulling down group margins. This seems to be higher than the £30m p.a. run rate that LFS had pre-acquisition and I just can’t reconcile that apparent increase with the cautious tenor of management’s comments, so may be FX is playing a part here. And there were no bold statements on global domination in Life & pensions BPO by the way!

I can understand what HCL is trying to do with LFS, i.e. move into ‘platform BPO’, and Life & Pensions is a hot market in the UK. But as with TCS, they are finding that (re)building the processing platform is a lot harder than expected. Meanwhile, Capita is reaping the benefits of having two major L&P competitors basically in stasis.

And what about the numbers? Well, HCL reported 11% yoy growth (22% ccy) to $512m including $37m inorganic. European revenues hit $139m, down 6% seq. as reported but up 15% ccy (including M&A). This puts HCL’s 2008 European revenues at just under $575m of which I’d guess some 80% comes from the UK.

All in all I think HCL is becoming an ever more interesting player to watch, especially here in the UK. Being under half the size of the TCS, Infosys and Wipro by worldwide revenues and with rather lower margins, it has to play the game differently. That’s what it appears to be doing, with a much stronger focus on ‘horizontal’ services in a narrower range of verticals. The formula seems to be working.