Hyderabad: The late 2008 acquisition of the UK’s Axon Group Plc. for nearly half-a-billion dollars and costs associated with a large currency hedge position may drag down the near-term financial performance of HCL Technologies Ltd, which is due to announce its January- March quarter results on 22 April, analysts predict.
Two multi-million-dollar deals announced in recent weeks with Xerox Corp. and Reader’s Digest Association Inc., they added, would show only in quarters later, not in the one gone by or the one to June.
HCL acquired Axon for $678 million (Rs3,390 crore now) in December, funded partly by a short-term loan of $585 million.
“HCL Technologies is expected to register the worst performance (among top Indian IT services firms), with a 12.2% quarter-on-quarter (q-o-q) de-growth estimated due to margin pressures, high interest costs and goodwill write-offs owing to the Axon acquisition,” said Mumbai-based Angel Broking Ltd.
Analysts Surendra Goyal and Vishal Agarwal of Citigroup Global Markets have also warned in their latest note to the clients to expect a 230 basis points dip in HCL’s margins on account of the Axon acquisition. A basis point is one-hundredth of a percentage point.
HCL declined comment as it is in a so-called silent period in the run up to the quarterly results announcement.
However, when the issue was raised in an analyst call with company management in late January, HCL chief executive Vineet Nayar had said that the cost of funds, at about 4.2%, was lower than treasury returns at his firm. “There should be no reason why we should not leverage our balance sheet,” Nayar had told analysts.
The $585 million debt, which is currently a short-term loan, is expected to be replaced with a longer term loan, though no clear timeline has been spelt out yet for the same.
Further, some analysts said bringing Axon, which specializes in the business software applications such as SAP AG, into the HCL fold when the global tech spending is slowing, may further prove to be a drag on the HCL bottom line.
Angel Broking analyst Harit Shah predicted margin dilution at HCL Technologies.
“The former (Axon) enjoyed Ebitda (earnings before interest, taxes, depreciation and amortization) margins of 16.7% in 2007 vis-à-vis 22.2% enjoyed by HCL Technologies in fiscal 2008. Axon’s PAT (profit after tax) margins are also lower at 9.9% vs 14.7% for HCL Technologies,” Angel’s Shah said in his note to clients. “We estimate 37bp and 38bp declines in Ebitda margins in fiscal 2009 and fiscal 2010, respectively, on account of the Axon acquisition.” By bp, he was referring to basis points.
Another concern is over HCL’s vulnerability to foreign exchange losses. As on December, HCL had hedged as much $1.5 billion and this, analysts said, could potentially expose the company to significant forex losses if the rupee depreciates as it has done in recent months. On account of forex hedging strategies it adopted, HCL suffered a $29.1 million loss in the previous quarter while in the two quarters before that, it had taken hits to the tune of $21 million and $70 million, respectively.
“Forex losses on effective hedges will chip away some of these gains (from Axon revenue). Pricing pressures and forex drag will likely result in a 700 basis point q-o-q decline in margins,” said analysts Bhavtosh Vajpayee and Nimish Joshi of brokerage firm CLSA Asia Pacific Markets in a note to their clients.
Still, some analysts are positive that the new deals announced by HCL Technologies in the last few weeks augur well for it in the long run. HCL had announced a seven-year contract worth $350 million from Reader’s Digest Association, besides a six-year contract from Xerox worth $100 million.