HCL Tech FV raised to Rs 900 on mega deal wins in core its areas

Bag full of surprises. We raise FY2021-23E EPS by 5-6% and Fair Value to Rs 900 from Rs 770 earlier following last week’s positive announcement. HCLT continues to impress with consistent mega deal wins in its core areas. This has translated into industry leading revenue growth in IT services on organic basis in FY2020 and provides comfort on expectations of consistent industry-matching growth. This deserves narrowing of valuation gap with peers and is captured in our FV. Separately, we move HCLT’s valuation to SoTP to capture differing growth dynamics of products and services businesses

HCLT continues to impress with —consistent mega deal wins in core areas of infrastructure services and large deals in ERD, signs of success in integrated deals, viz. apps and infra, and improved digital competencies courtesy focused investments in the past three years that shows in strong growth in Mode 2 revenues. The outcome of this is robust growth, which was industry-leading at 10.7% on organic c/c basis in FY2020.

Revenue decline will be contained in FY2021 to a marginal 2.2% on organic basis. Basis the strong deal momentum, signs of success in integrated deals and recent mid-quarter update from the management, we raise FY2021-23E revenue estimates by 2-4% and EPS by 5-6%. We forecast IT services+ERD revenue growth of 11.4% in FY2022E (10.3% on organic basis) and modest growth of 2% in products business.

SoTP-based valuation captures the differing growth dynamics for products and services businesses. The services business has leadership in ERD, infrastructure services and improved competencies in applications. We believe that the services portfolio can match peers on growth. The growth rate has been achieved largely organically except for a few tactical acquisitions done in the past 3-4 years.

The services business can trade up to 18-20X NOPAT, a 20% discount to Infosys. We value the product business at 7X Sep-22 Ebitda. This translates into valuation of US$4.5 bn for products business that effectively captures— organic product development and the acquisition consideration for a portfolio of IPs. Management indicated that IRRs on product can potentially be 14-15%; we await a sufficiently long track record before taking a more constructive view.

The lower multiple for products captures the weak growth prospects for the business.
We believe that HCLT’s net cash balance will bloat to US$3.7 bn, which we add to arrive at a revised SoTP-based Fair Value of Rs 900.

HCLT has announced the acquisition of Australia-based DWS for an equity consideration of A$162.1 mn. HCLT will assume debt of ~A$25 mn. DWS is a generic ex-growth IT services company and reported revenues of A$168m in FY2020 (June fiscal year-end). The company reported GAAP net profit of A$7.5m and underlying net profit of A$16.9m in FY2020— effective acquisition of the company at 9.6X underlying earnings. The transaction will be EPS accretive for HCLT.