Prabhudas Lilladher recommended accumulate rating on HCL Technologies with a target price of Rs 1100 in its research report dated December 08, 2018.
Prabhudas Lilladher's research report on HCL Technologies
HCL Tech surprised the street announcing an intent to acquire IBM IP products (7 Software Products) for a consideration of USD1775mn (Including earnout). The acquired products would have revenues of USD625mn in the first year of acquisition and USD650mn revenues in the second year for acquisition. This implies HCL Tech is valuing the acquired business at P/S of 2.8x. The acquired products have an EBIDTA margin of ~50% and the deal is likely to be cash EPS accretive by ~15%. HCL Tech expects to close the acquisition by mid CY2019 (2QFY20E) and 48% of the purchase consideration is expected to paid on closing date of the acquisition (~2QFY20E). A majority of the remaining payout is expected to be done post completion of one year of the acquisition (2QFY21E). Owing to lack of clarity on amortization policy, the EBIT margin outlook of the acquired products is not yet disclosed. However, if we use 10 years' amortization of the total outgo, the EBIT margin of the new products would be ~ 23% for FY21E as per our view. While some of the products acquired (Appscan, DX) are in high growth markets, select other acquired products (Notes) are cash cow business.
Outlook
As on 2QFY19, HCL Tech has a goodwill and Intangible assets (which includes Licensed IPR) of USD2.5bn (USD1.3bn goodwill and USD1.2bn intangible assets). Post the new deal, the total Goodwill and Intangible asset on Balance sheet would be ~USD4.3bn on Balance sheet. Owing to the huge Intangible asset and goodwill created in the balance sheet, substantial moderation of net cash position on balance sheet and strain on free cash flow trajectory, we trim multiples for the stock. We now value HCL Tech at 13x Sep20E EPS (vs 14.5x Sep20E EPS earlier) which yields a TP of Rs1100/sh. This represents a 13% downgrade in target price led by P/E multiple downgrade.
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