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More optimistic on profit margins after deal with IBM, says HCL Tech CFO

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HCL Technologies (HCL) on Friday said it would buy some of the software products of International Business Machines (IBM) for $1.8 billion. To get a sense of the deal rationale and how it would benefit HCL, CNBC-TV18 spoke to C Vijayakumar, CEO & Prateek Aggarwal, CFO of the company.

More optimistic on profit margins after deal with IBM, says HCL Tech CFO
HCL Technologies (HCL) on Friday said it would buy some of the software products of International Business Machines (IBM) for $1.8 billion.
The software products in scope represent a total addressable market of more than $50 billion, IBM said in a statement. The transaction is expected to close by mid-2019.
To get a sense of the deal rationale and how it would benefit HCL, CNBC-TV18 spoke to C Vijayakumar, CEO & Prateek Aggarwal, CFO of the company. Here is the full transcript of the interview:
Q: What the rationale behind this deal?
Vijayakumar: The strategic rationale is that first and foremost we did IP partnership on 5 of these 7 products in the last two years and we have been able to bring in product innovation and create the right type of growth. So it gave us a lot of confidence on what we can do with the products that was the foundational reason why we pursued and it worked very well with IBM for us to conclude this deal.
Q: A question with respect to the payment and the payout of the deal. So $1.8 billion, I saw the details of your release – $1.7 billion roughly in cash and $300 million in debt. Can you clarify if this is correct and can you give us some more detail with respect to if there is a cash consideration, if there is a share swap involved in this as well?
Aggarwal: This is a pure cash deal. The total number including earn out is $1,775 million which we are rounding off to $1.8 billion. Roughly about half of it, about 48 percent of it is to be paid at close which we expect to be by middle of calendar 2019 and most of the balance would be paid after end of one year after close.
Most of this $1,775 million is going to be internal accruals, financed by internal accruals except a small amount of about $300 million which we might raise in at close because some of our funds are locked up in FDs and long-term bonds etc and that’s the only reason why we are raising it otherwise we expect to be cash positive going forward as well.
Q: So the $300 million you will take if required, that may not be a requirement as well if the capital comes in by that point – so that is basically mid-2019 when that debt will be taken, correct?
Aggarwal: That is right, it also depends on when we get all the approvals etc., which is an external factor which we cannot accurately predict, so depending on the date we might have to take or if it gets delayed we may not need it.
Q: What would the impact be on margins and by when will this impact fall on the company. Can I assume then that only by FY20, first or second quarter, will that impact come in?
Aggarwal: Yes. This is going to be a very profitable stream of revenue and business. So when we published our Mode 3 margins in the last couple of quarters, they have been running at 24-25 percent – that is EBIT of course. However, in EBITDA terms, in cash return terms it is going to be about 50 percent of the revenues.
Q: Would you maintain your margin outlook at the current levels in this case and what would that band be?
Aggarwal: As I said, we are comfortable at 19.5 and 20.5. However, this being a large transaction with significantly higher profitability than our standard profitability levels, there are reasons to be little more optimistic but I would wait for FY20 guidance – that’s the time we will look at it more comprehensively.
Q: The revenue is going to come in once the deal closes, correct? In that case, what would the exact annual revenue addition be or quarterly revenue addition be. Whatever number that you can share with us?
Aggarwal: We expect the revenue run rate, the incremental revenue that we get out of this deal because for 5 out of these 7 products we already have the revenue in existing revenue stream. On an incremental basis, on a run rate basis we expect about $650 million per annum. It will be slightly lower in the first 12 months after the deal closes because of transition issues, it will be about $25 million lower but the run rate should be 650 going forward.
Q: The Street may argue that it’s a large value for acquiring just a portion of IBM’s product business, just playing the devil’s advocate here, how would you justify that?
Aggarwal: Financially it makes a lot of sense. As a business strategy it gives us strong annuity revenue streams, access to a very large market potential. All of that is very good for HCL across our Mode 1, 2, 3 offerings and even from revenue and EBITDA multiple it is quite an attractive deal.
 
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