Why HCL-IBM deal is failing to excite investors

Shiv Nadar. The HCL-IBM deal, which accounts for nearly 22% of HCL Technologies’s annualized revenue, is expected to close by mid-2019. Photo: Priyanka Parashar/Mint

Shiv Nadar. The HCL-IBM deal, which accounts for nearly 22% of HCL Technologies’s annualized revenue, is expected to close by mid-2019. Photo: Priyanka Parashar/Mint

Mumbai: Investors in the Shiv Nadar-controlled fourth-largest Indian IT services provider, HCL Technologies Ltd, were not enthused with its Friday announcement that HCL Tech will buy select IBM software products for $1.8 billion. HCL Tech shares fell as much as 7.60%, on a day the BSE IT Index traded lower and Sensex was higher.

The HCL-IBM deal, which accounts for nearly 22% of HCL Tech’s annualized revenue, is expected to close by mid-2019, subject to completion of applicable regulatory reviews. It is also the largest acquisition by any Indian IT services provider till date. Tech Mahindra Ltd acquired Satyam Computer Services for $1.23 billion in March 2012 while HCL Technologies bought the Axon Group for $731 million (Infosys was in the race but had made a lower bid at $678 million).

Both companies appear to have struck this deal in a bid to focus on their core strategies. On its part, HCL wants to sharpen its focus on its “products and platforms” business, which accounted for $250 million of its revenue in the September quarter, in a bid to grow its intellectual property (IP) business.

On the other hand, the deal follows International Business Machines Corp.’s (IBM’s) attempt to make a dent in the open source hybrid cloud market. It was only a couple of months back that the Big Blue agreed to buy open source cloud services provider Red Hat Inc. for $33 billion.

ALSO READ | Why does Big Blue really want a Red Hat?

HCL and IBM have an ongoing intellectual property (IP) partnership for five of the products in the deal announced on Friday. The software cumulatively represent a total addressable market of more than $50 billion.

According to HCL Technologies CEO C. Vijayakumar, HCL is acquiring these products that are in “large growing market areas like security, marketing and commerce, which are strategic segments for HCL… In addition, we see tremendous potential for creating compelling ‘as-a-service’ offerings by combining these products with our Mode-1 and Mode-2 services”.

HCL’s so-called Mode 1 refers to its application, development and maintenance (ADM) and infrastructure services. Mode 2 refers to its growth businesses that are oriented towards digital technology, such as mobility, Internet of Things (IoT), automation and Artificial Intelligence (AI).

DRYiCE, for instance, is a division of HCL Technologies that is focused on building AI-powered “products and platforms” for the digital world. HCL Tech’s Mode 3 refers to the “products and platforms” business, which has more IP-based solutions that provide higher margins, are better for business and provide longer-term engagements.

However, HCL Tech’s decision to acquire software from IBM as part of its attempt to be IP-driven and drive growth on back of it may be “good in theory, and the bold move is a step in the right direction, but the ground reality is that these products come with a ton of baggage that can potentially throw a spanner in the works”, according to Sanchit Vir Gogia, chief analyst, founder and CEO of Greyhound Research, a market research and analysis firm.

Gogia argues that most of the products in the HCL-IBM deal have been sold “as part of a large Strategic Outsourcing or a Managed Services deal and not as independent products”. This implies that so far these products “have been sold on back of the solid relationship with IBM, existing services contracts and most importantly, the ability to covert CAPEX (capital expenditure) to OPEX (operating expenditure) thanks to IBM’s financing arm”.

“When sold independently, HCL Technologies will need to add ammunition in terms of integrations with other key third-party providers, soft licensing measures, the ability for these products to work across multiple cloud providers and most of all, the arms and legs to allow for easy deployment and ongoing management,” says Gogia. He believes “HCL Tech can turn the deal in its favour if it offers concrete guidance on its commitment to code and R&D overall”.

HCL Technologies, on its part, believes that the addition of a customer base of about 5,000 clients to its existing repertoire will help it make the deal enhance its existing business. The company is also expecting that the deal will add $650 million annually to its existing business ($625 million in the first year of completion).

Mint’s Ravindra Sonavane contributed to this story.

First Published: Fri, Dec 07 2018. 02 01 PM IST

Source: Livemint