HCL Tech today saw some selling pressure on the news that it will buy select IBM’s products for $1.8 Billion. The stock closed 5% down from its previous low.
HCL Tech and IBM already have an ongoing IP Partnership for five of these products and management believes that a total addressable market for these products are more than $50 Billion. (Source: https://www.hcltech.com/press-releases/products-and-platforms/hcl-technologies-acquire-select-ibm-software-products-18b)
Understanding the deal:
Total Purchase Price: ₹ 12,780.00 Crores (Approx.) (Assumed $ at ₹71)
To be financed through: Internal Accruals – 83%, Debt – 17%.
Expected Revenue: ₹4,550.00 Crores (Approx.) on annual run rate basis from 2nd year of the deal i.e. mid 2019.
| Year | (in ₹ Crores) | |||||||||
| Particulars | 2 | 3 | 4 | 5 | 6 | 7 | 8 | 9 | 10 | Total |
| Annual Inflows | 4,375.00 | 4,550.00 | 5,283.69 | 6,135.68 | 7,125.06 | 8,273.98 | 9,608.16 | 11,157.47 | 12,956.61 | |
| PVF | 0.78 | 0.68 | 0.60 | 0.53 | 0.47 | 0.41 | 0.36 | 0.32 | 0.28 | |
| PV | 3,396.74 | 3,112.71 | 3,184.98 | 3,258.93 | 3,334.59 | 3,412.02 | 3,491.24 | 3,572.30 | 3,655.24 | 30,418.74 |
| Cash Accretion | 509.51 | 466.91 | 477.75 | 488.84 | 500.19 | 511.80 | 523.69 | 535.84 | 548.29 | |
| PVF | 0.78 | 0.68 | 0.60 | 0.53 | 0.47 | 0.41 | 0.36 | 0.32 | 0.28 | |
| PV Cash | 395.58 | 319.42 | 287.98 | 259.64 | 234.09 | 211.06 | 190.29 | 171.56 | 154.68 | 2,224.31 |
| O/s Shares (crores) | 135.6 | 135.6 | 135.6 | 135.6 | 135.6 | 135.6 | 135.6 | 135.6 | 135.6 | |
| Cash EPS | 3.76 | 3.44 | 3.52 | 3.61 | 3.69 | 3.77 | 3.86 | 3.95 | 4.04 | |
| EPS | 3.30 | 3.02 | 3.09 | 3.16 | 3.24 | 3.31 | 3.39 | 3.47 | 3.55 | |
Roughly this means that even if everything goes as per what management is expecting, then this deal will hit break-even point after more than 20 years. This acquisition could add up to ₹ 3.30 to FY20 EPS. Assuming market assigns current multiple of 15.3X this should add 6,842.91 Cr to the market cap from FY20 onwards. The deal is valued at 2.84X the sales, while company is valued at around 2.64X the sales, implying company paid slightly on the higher end. Overall outflow of 12.78 K Crores will reap benefit to the company only if it is able to achieve synergies and cross products benefits. This factor remains the cause of utmost concern for the investors.
Rationale:
-HCL Tech’s FY18 total sales at $7.1 Billion.
-Products acquired have market opportunity of $50 Billion.
-Products within Top Quadrant by industry Analysts & provides access to wide range of Geographies through 5000+ global enterprises.
-Currently 5 of the 7 products already add to the existing revenue, the revenue generated on and above this will be of $650 million.
-The management is confident of these products as it already caters this market, as compared to the risk of newer product development.
(Above calculation is done by taking 13.49% as the WACC for the company, Growth of revenue is assumed to be at 16.13% which is the average growth of all the acquired products, Cash accretion is 15% of the revenues as expected by the management, EPS is roughly 87.7% of cash EPS.)
Understanding the products:
| Product | Market | Market Size ( ₹ Cr.) | Growth Rate | Position | # of Clients |
| AppScan | App Security | 19,600.00 | 26.40% | Top 3 | 2,000.00 |
| Big Fix | Endpoint Management | 1,03,600.00 | 8.40% | Top 3 | 2,200.00 |
| Notes | Enterprise Email | 2,28,200.00 | 5.00% | Top 3 | 13,000.00 |
| Domino | Low Code | 30,100.00 | 45.00% | NA | |
| Connections | Enterprise Collaboration | 2,42,900.00 | 11.60% | Top 3 | 2,000.00 |
| DX | Digital Experience | 67,900.00 | 14.00% | Top 3 | 1,400.00 |
| Unica | Market Automation | 35,000.00 | 8.60% | Top 3 | 600.00 |
| Commerce | Digital Commerce Apps | 45,500.00 | 10.00% | Top 5 | 425.00 |
Since company was already in an ongoing partnership with the IBM for five of the products, we believe management has a fair understanding of the products, its markets and revenue potential hence buying these products won’t be a new venture or speculation but a calculated investments into an opportunity. Though many analysts are of the view that IBM would have factored in the headroom for growth, usage and profitability for these products before offloading. However, we are of the view that these products could create synergies for HCL Tech. Also HCL tech will access to new markets through these products which will help them cross-sell in those markets creating synergies within existing products. The acquisition also entitles them to on-board new customers (users of these products) as well as the workforce attached to them. Further data is required to precisely analyse how much of these benefits will be accrued to the company.