HCL Tech says next 60 days crucial for Indian IT industry

Four-and-a-half percent growth in volumes despite discretionary spend being under significant threat, as I told last quarter, I think it was an all-round performance.

Vineet Nayar

CEO & VC

HCL Technologies

HCL Tech  will go for another round of wage hikes in October-December period, said CEO and vice chairman Vineet Nayar. "We believe the next 60 days are going to be very crucial for the Indian IT industry," he told CNBC-TV18 in an interview.

The IT major reported a 78% (4% sequentially) rise in net profits to Rs 885 crore, sending its shares to a 52-week high. India's fourth largest software services provider topped street expectations, in sharp contrast to its Bangalore-based rival Infosys, which had last week reported second quarter net profit in-line with expectations but not without concerns.

Nayar said increased offshore and higher utilisation helped margins. However, he said discretionary spend remains under pressure in the near-term. 

HCL Tech's strong earnings growth came on the back of several new deal wins and growth across its key geographies of US and Europe, which grew 18% and 17% respectively in US dollar terms on a LTM (last twelve months) basis. "Our focus shift towards US and Europe will continue until 2014," Nayar said adding, the IT major does not see any significant impact by the US elections.

HCL sees deals worth USD 40 billion coming up for renewal in October-March. "We see significant opportunities till February-March 2013," Nayar said.

Below is the edited transcript of the interview with CNBC-TV18's Latha Venkatesh and Udayan Mukherjee.

Q: Volume growth surprised the street positively. Would you say its infrastructure services that delivered or would you take heart from the fact that financial services also turned in a four percent growth this quarter?

Nayar: I think healthcare turned in a 14 percent growth, manufacturing turned in a good growth, media entertainment saw a 10 percent growth, and financial services saw a four percent growth. It was actually 'run the business' growth drove the volumes up.

Four-and-a-half percent growth in volumes despite discretionary spend being under significant threat, as I told you last quarter, I think it was an all-round performance. Obviously infrastructure guys continue to do extremely well.

Q: The big surprise is on the margin front as well. This is a wage hike quarter. Most investors thought that HCL will report a dip in margins. You have actually come in with a strong margin performance. What worked for you on the margin front this quarter?

Chanana: What worked for us in this quarter and has been working for us for quite long is the ability to manage the margins. We invest when the deal comes in and do it very successfully with zero defects, and move the work offshore. This is what significantly happened in this quarter. So, offshore percentage went up by 150 bps. This is one reason. Our utilisation went up. In the managed contracts, we have been able to successfully deploy the people more optimally. So, these are the two significant reasons that have led to the margin being intact.

Nayar: When we did USD 2.5 billion deal in October to March, the question you asked is 'were they done at lower pricing?' You are seeing pricing of those deals flowing through our P&L now. Therefore, those deals were done at extremely good margins.

Q: I am just reading some TPI data. It suggests there is a USD 30 billion rebid opportunity in October to December. This is a quarter typically where you snap up fairly significant deals which you milk over the four quarters to come. How is this October- December shaping up for you? What are your expectations?

Nayar: We are ending up being very predictable. We ramped in a lot of deals in October to March last year. We put our head down to execute it. Our hunters are back in the market. We believe the next 60 days is going to be a very decisive phase in the IT industry because TPI has predicted H2 is going to be 100 percent more in deals compared to H1 (first half).

All our guys are in the market, including me (I am flying out today to US) because October-November-December is booking time.

Q: The same data points also seem to suggest that 2013 could be a better year for 2012 in terms of deal rebids, USD 120 billion. More than USD 100 billion seem to be from the infrastructure related space. Does that give you a clear advantage, since that is your bread and butter?

Nayar: I hope so. I think this news is good till 2014. In 2015, these renewal tapper off. So, yes, the news is very good and also infrastructure is leading the charge in the deal renewal. Our success ratio, this quarter, has been 51 percent which is the win ratio. If we can maintain win ratios in excess of 40-50 percent, I think we are in a pretty good shape till 2015 from a deal win point of view.

Q: More offshore and higher utilisation, are these one offs in the current quarter because of specific deals or do you spot some kind of trend there?

Chanana: It keeps on varying quarter-on-quarter (QoQ). But when the deal came in, in the last two quarters, we had made significant investments in making the transition happen successfully. So, onsite had shot up. This quarter the worked moved offshore and we could gain out of it.

Not only the margin had expanded both at the EBITDA level and the net income level, but also the return on the shareholders funds, the return on equity significantly went up. It has reached 27 percent. That is among the best in the industry.

Q: In this October-December quarter, which you say is very crucial, this time when you go in for the rebids, do you expect even more heightened competition from some of your local peers because they have been under pressure with their performance? Do you think pricing or issues like that could get even more competitive this time around in the deals that you are speaking about?

Nayar: In any industry, there is a head start advantage which HCL has. The initial consideration list will obviously have more people than we had before. But I think the final three is going to be largely the same.

We are sharply focused on global MNCs. I do not see a significant change in the final three final four. Therefore, I do not see any change in trajectory or pricing, deal terms or how the deals are done or the margins of those deals.

Q: Do you see yourself better positioned in the US market in this current quarter for deal snaps or even the European market is looking promising?

Nayar: Over the last four quarters we have defocused a lot from rest of the world and shifted our energies in US and Europe. Therefore rest of the world has degrown three or four quarters sequentially. Our US and Europe revenues have grown substantially.

We saw the opportunity about four quarters ago in US and Europe. We continue to see that trajectory till 2014. Therefore, all our energies are in US and Europe rebid. In October-November-December the European rebid is larger than US rebid. Therefore Europe is attracting a lot of attention from HCL.

Q: Do you see this as just a temporary October-December window of opportunity or as you have said the second half is strong this could be an October-March kind of a window of an opportunity?

Nayar: It is an October-March kind of an opportunity as it was last year. In 2008, just after recession in September, October onwards there was a significant opportunity that we grabbed. Last October to March we grabbed. This October to February-March definitely, there will be a lot of opportunities. It will slowdown in April to October and then it will come back again.

The good thing about the renewal market is that one would exactly know the date on which the contract is coming to an end. Therefore, there is a predictability that the contract is going to be signed at least nine months before the contract comes to an end. With that predictability, one is assured of what market momentum will happen.

The only two variables in that is will the customer move away from existing vendor to a new vendor, which right now is running at 30 percent because of the huge dissatisfaction the customer has with existing vendor. Secondly, would you win if the customer swings?

If those two variables are managed, there is a huge amount of predictability on what kind of booking one would be able to execute in what quarters and what period of time. It would result in scaling down sales and marketing expenditures and putting them into engagement management and customer woes, then recalibrating and moving them into hunting, so that some of those deals can be won. One an easily do that because this market is quite predictable in when it would decide what.

Q: How have the forex piece played out for you in the current quarter? How are you approaching the October-December quarter as well on the forex front given the recent snapback in the rupee-dollar?

Chanana: In the July-September quarter, it did not impact adversely because there was only a negative moment on an average of 0.3 percent, meaning the rupee appreciated on an average by 0.3 percent. In this quarter, we followed a layered hedging policy which is benefitting us. However, the average rate is likely to come down because it is hovering around Rs 53. Depending upon where we end, it will have an impact on the numbers.

Q: In such a critical period that you just described you have the US election results also coming in in November. I know it is probably more hype than anything, but do you see that impacting deal awards in any significant manner or having any hangover on the margin?

Nayar: No, I do not think so. Most of the deals, which we have focused on are not in the government area, which we are not very strong on. It is largely corporate deals coming to renewal. Most of them are small sub-USD 500 million, so they do not get the kind of attention. We have already announced that we will create 10,000 new jobs in US and Europe.

Therefore, being socially responsible is a big mantra which we are chasing. In this political environment, it is very, very important to be projected as a company which is creating jobs. With a combination of all these things, I would not worry about the deals not moving to an offshore player like HCL or any impact it would have on margins. I am confident and we have baked that in our strategy.

Q: Do you see this divergence which has been in place for the last many quarters that discretionary spend and players focused on discretionary spend are struggling while infrastructure management as a space has clearly worked out for you. Do you see this trend continuing or even getting more pronounced for the next 3-4 quarters?

Nayar: I cannot comment on other players, because it is a matter of what their strategy is and what their execution is. From our point of view, discretionary spend is under pressure and will continue to be under pressure at least for a few quarters more. Therefore that 50 percent of HCL revenue will be under significant pressure. I do not see how we are going to come out of it unless the economy starts improving.

From the run-the-business, which is 50 percent of our business we are actually executing extremely well. HCL's growth and increasing the market share is only happening by 50 percent of the HCL engines firing. Imagine what would happen when 100 percent of the engines start firing. We are very sharply focused on only few markets, executing that extremely well, with 51 percent win ratio, we are spending our sales dollar extremely well and doing one thing well and driving the whole growth in the company.