NEW DELHI :
HCL Technologies Ltd has clarified that its $1.8 billion acquisition to buy eight software products from International Business Machines Corp. (IBM) announced last month will have an operating margin of 30%, higher than the 19.6% profitability in the services business at India’s third-largest information technology (IT) services company.
Noida-based HCL Technologies will also recognize amortization and depreciation costs at a fixed rate over time, rather than its earlier approach of booking such expenses based on the revenue it generated.
“Directionally, we believe it’s (amortization costs) still not final. (And) we are still working through some details. But it will be like any other software acquisition. Our expectation is that amortization will be around 20% of the revenue," HCL Tech chief executive officer (CEO) C. Vijayakumar said in an interview on Tuesday.
An amortization of 20% of revenue implies that HCL Tech, which in December had outlined an annual 50% EBITDA (earnings before interest, tax, depreciation and amortization) margin from the acquisition, will operate its product business at a 30% operating margin. It expects to close the acquisition by June 2019.
“It (amortization costs) is most likely to be a straight-line method," said Vijayakumar, who took over as CEO in October 2016. HCL Tech expects the eight software products, such as IBM Notes, Domino and Appscan, to help it garner $625 million in incremental revenue in the 12 months after the completion of the deal.
Vijayakumar did not share the revenue numbers from each of the eight products, few of which are considered by analysts as matured and legacy products not seeing much growth.
“(IBM) Lotus Notes has got two components. There is Domino, which is a development platform, the adoption of which is very high. Traditionally, IBM didn’t spend time to modernize it. In the last one year, we have modernized the whole Domino platform. So the adoption rate of Domino is very high. Notes adoption may not be very high and may decline. (But) the whole strategy is around Domino," said Vijayakumar.
HCL Tech’s explanation is significant for it assuages some of the concerns of the analysts who, until now, were not certain about the profitability of these products. The company’s earlier approach of recognizing amortization and depreciation costs based on the revenue it generated had made a few analysts queasy.
They were unhappy because HCL Tech appeared to be boosting profitability in the near-term as it was pushing back expenses to the latter part of the life of the contract.
However, there are two unanswered questions with regards to its purchase of software products from IBM, in the single-largest acquisition by an Indian IT firm.
First, there is a mismatch in revenue, as HCL Tech expects to get $650 million from the products, while IBM last week told analysts that the products generated $1.3 billion in revenue in 2018.
On Tuesday in a post-earnings call with analysts, HCL Tech chose not to comment when Ankur Rudra, an analyst at brokerage CLSA, asked the management about the reason behind the difference in revenue numbers.
Analysts also await some clarity from the company on the tenure of amortization and whether there will be any change in profitability after the company changed the way it recognizes amortization expenses. Nonetheless, a few analysts believe that it is too early to conclude on HCL Tech’s approach of scaling up business from its software business, which accounted for 11.9%, or $263 million, of the company’s $2.2 billion in revenue in the third quarter.
“Above all, what matters most is how the company executes and scales up business from products it has bought. Until now, HCL (Tech) has a good track-record and so it is only fair to wait for some time (to find out) how the company fares in the coming months," said an analyst at a foreign brokerage, requesting anonymity.
Lokesh Yadav contributed to this story.