BRICS Securities puts SELL on HCL Technologies

BRICS Securities puts SELL on HCL Technologies

While management has clarified that it has no exposure to Lehman or Merrill Lynch, it has conceded that the near term would be challenging.

The company expects one BFSI client to ramp down in the current quarter, while two others to remain "flattish". They also gave out the now familiar spiel of drawn out sales cycles. We understand that HCL Tech has minimal exposure to the visible queue of financial institutions lined up for capital infusion or bailouts.

Going forward, HCL Tech has indicated that they were actively scouting for acquisitions in BPO and enterprise solutions segment. In BPO, we would expect to see carve outs from captive units like the recent Philips Infosys deal.

Enterprise solution is also a horizontal where HCL Tech lags the other top tier players. However, they refrained from commenting on a dedicated fund for IT acquisition or the widely speculated Axon counter bid from HCL Tech.

The management has also retained its focus on outcome-based and fixed price projects. The sales pitch here would quantify the cost savings over the life of the project and offer it to the client.

We believe that we might see some contracts with upfront payment of cost savings and maintain our cautious stance on deals with upfront payments and aggressive outcome-based structuring due to limited visibility on profitability and project ramp.

Out of the tier-1 IT companies, HCL Tech is expected to be more aggressive in getting deals bundled with upfront payments (after Tech Mahindra), particularly as the pressure to lock in revenue for H2FY09 and FY10 rises.

The company has clarified that the forex hit on its hedging positions will not be significant in this quarter, as losses are offset by translation gains. The company will have $300 million of MTM hedges this quarter versus $580 million last quarter.

We continue to believe that the turmoil in the financial markets will have a cascading effect on outsourcing drive of sectors like retail, automotives and aerospace in the next three quarters. HCL Tech is currently valued at P/E of 10.1x our FY09 EPS estimates. We maintain out negative stance on the IT sector and our SELL on HCL Technologies.