HCL Infosystems-From hardware to software-A good investment?
From hardware to software
The stock price of HCL Infosystems has been rising since July 1998 because of restructuring. Will it still rise? Shalini Gupta reports
HCL Infosystems (HCLI) is now going strong at Rs 500, up from around Rs 30 levels in March 1998. Even in July, the scrip was available at Rs 97. The 'action' in the scrip started only after that. The rally ostensibly was triggered by the measures to improve transparency, which the company initiated in June 1998. Three subsidiaries of HCLI — HCL Infosolutions, customer support division of HCL Office Automation and HCL Peripherals — were merged with it.
Skeptics, however, believe that the decision to merge and therefore have more transparent operations was spurred by the desire of the group to have HCLI listed on an American stock exchange. With a simpler organisational structure, investors would feel more comfortable investing in Shiv Nadar's business now.
Greater transparency and disclosures
Prior to this integration, distribution of HCL products was routed through several HCLI subsidiaries. For instance, HCL Infosolutions used to distribute computers which had been purchased from HCL Corporation by HCLI, and it also provided integrated solutions. Under a similar arrangement, HCL Peripherals used to distribute peripherals like keyboards and other accessories and HCL Office Automation used to distribute office equipment (Canon and Toshiba copiers until recently. The relationship with Canon has now been terminated). Understandably, the demise of this complex arrangement was received well by the market.
Improving quarterly results
Since the merger in June 1998, the company has been posting increasingly good results — for the second quarter ending December 1998, the growth in income from operations was 57 per cent, over the corresponding period last year. Growth in operating profit was also 276 per cent and operating profit margins shot up to to 9.1 per cent from 3.8 per cent earlier.
One reason for the good results is the merger which showed consolidated results. Another is the company's increasing focus towards software, which provides higher margins than hardware. Analysts expect the 80:20 ratio of hardware to software in 1997-98 to change to 70:30 in 1998-99.
In fact, analysts say, HCLI has plans of evolving into a full-fledged information technology (IT) player. So it will not only manufacture personal computers but will also undertake system integration (SI) contracts — bundling of software services and support. The company will be using its hardware business to get a foothold in the software services business. Additionally, it will undertake software projects.
Sound business strategy
How sound is this strategy? Says Aditya Srinath, analyst with SSKI, "The hardware business is a very low margin business. Thus it makes sense to branch out into software, particularly if the infrastructure is already in place." (Details of the existing infrastructure given under 'Existing resource base'). Already, the company is concentrating on the more profitable enterprise solutions segment and SI contracts, where margins are higher.
For software within India, HCLI already has a relationship with leading corporate clients developed because of its hardware business. For overseas business, the company has the advantage of sharing the common marketing network for all HCL companies. The company already has five factories and about a 1,000 strong manpower.
Further, Srinath says, "Growth in the near term will be internet driven and will be mainly retail. Over the same time horizon, corporate demand is unlikely to pick up. Thus, the company's stress on retail is sound. Over a five-to-seven year time horizon, growth will be driven by IT requirements in infrastructure and investments in information technology. Hence the company's continuing stress on the government segment is far sighted."
Also, traditionally, within the hardware sector, retail personal computers (PCs) are much less profitable than institutional sales — apart from cut-throat competition, the need to hold pipeline inventories puts pressure on profit margins. In the institutional business, players make economic returns in two ways — by minimising working capital demands and by using system integration (SI) or services to subsidise hardware sales, provided the players are able to manage their debtors.
Within hardware, the company is no longer chasing sales at the cost of profits. Profitable customers, who offer good credit terms, are being concentrated on. In fact, this focus of the company is visible even in 1997-98 when the debtor days fell to 72 from 84 in the previous year. Interest burden (mainly on account of short term loans) also fell to Rs 11 crore (Rs 110 million) from Rs 45 crore earlier.
Existing resources base
The company already has the resources in place for evolving into an integrated IT player. It is a leader in the PC market (institutional and retail combined). In the institutional business, the company is reasonably strong. This is because PCL which was the strongest player in the institutional market is no more active. Thus, there is a gap which HCLI is trying to fill. HCLI's chances of filling this gap are much more than that of the others because of the depth of relationship it already has compared to the others — HCLI has been doing business with NIC (National Informatics Council) for many years now. In fact, NIC is HCLI's main client. NIC is increasingly becoming an influential advisor to the government on IT.
In hardware, distribution is emerging as a key to succeed in the retail segment of the market. It is the fastest growing segment (100 per cent last year), and accounts for about 20 per cent of the total PC market. HCLI has a good distribution network of 800 resellers across 140 cities. HCLI also owns five retail showrooms in the metros and an extensive network of franchisee outlets. The network dwarfs competition. Wipro, for example, had about 100 direct sales engineers and a network of about 250 dealers last year.
HCLI is using the same distribution network to service another emerging segment of the market — the small and medium enterprise segment (SME). However, this market is still nascent and would need to be developed. Last year SMEs comprised about 25 per cent of the market and were growing at above 50 per cent.
The company has broken all price chart trends. Though the company is moving into software, the ratio of hardware, which is essentially low margin, still remains 70 per cent. Thus the huge price movement is not warranted by the change of strategy. Yet, analysts feel that the share price may go even higher given the euphoria surrounding the software sector. Buy for the short term to get quick gains.
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