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HCL Tech’s Acquisition Of IBM Products Raises More Questions Than Answers

HCL Technologies Ltd’s $1.8-billion acquisition of some software products from International Business Machines Corp. (IBM), touted to be its biggest ever, met with much scepticism. The stock has lost 5% since it announced the acquisition last week.

The firm’s argument is that the acquisition will give a leg-up to its products and platforms business, and the share of this segment will rise from 12% of revenues to 17%. HCL Tech aims to leverage the market access provided by these products to cross-sell its existing services, benefiting in the process. Still, everybody is not convinced.

Some of the products being acquired are seen to be mature technologies with a declining market share. “The company has not provided individual product revenue contribution. Concentration of revenues in favour of legacy products could be a risk to overall growth of the portfolio,” analysts at Nomura said in a note.

Investors also have questions about HCL Tech’s ability to scale up the products business. Being a software services company, it has limited capability in product sales. True, the IBM deal gives it headway. But HCL Tech will have to market the product and build a sales team, which is easier said than done. “(HCL’s) the capabilities for product sales are untested and HCL will be handicapped in tapping new clientele in competition with entrenched software vendors,” add analysts at Nomura Research.

HCL Tech may step up investments in sales and brand development. But this can raise costs and weigh on profitability. Further, post the large payout for the acquisition, cash levels at the company will reduce considerably, limiting the scope for tactical investments in future. Maintaining its dividend payout ratio could also become a challenge if operating cash flows decrease or CapEx rises from current levels.

While the concerns are expected to weigh on stock performance, much depends on execution. If HCL Tech succeeds in product platform investments, then the company can emerge as end-to-end solutions provider, point out analysts at Elara Securities (India) Pvt. Ltd. The reaction of the stock, however, shows that not everyone agrees. – Livemint

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