HCL Infosystems Ltd which was facing uncertainties in India regarding its contract expiry of Nokia mobile phones distribution, has come up with a surprise move of acquiring 20% stake in Dubai headquartered Techmart Telecom which distributes Nokia smartphones across Middle East and Africa.
The share sale agreement leaves space for HCL Infosystems to hike its stake to 51% in the future, which will, of course, amount to a takeover. Also, HCL Info which has built up one of the world's most extensive Nokia distributions - in India - is expected to deliver certain services to Techmart Telecom.
The move comes at a critical time for HCL Infosystems' (BSE: 500179, NSE: HCL-INSYS) investors and potential investors, as the scrip has been recovering from an almost 11-month slide, with the reprieve coming only within the month-to-date. Even now, the recovery is not full with HCL Infosystems down over 23% year-to-date.
The Nokia business continues to be critical for HCL - as critical as it was in 2006 - when the scrip was hammered when Nokia took over 50% of the India distribution from HCL, but extended the contract with the Indian company for another five years. This extension is the one which is going to expire by February-March 2011.
Though HCL doesn't provide the exact break-up of the Nokia business, it is estimated to be a major chunk of its 70% revenue segment of Telecom & Office Automation, and as such, any adverse move from Nokia can significantly impact HCL Infosystems.
20% of Techmart's $540 million annual sales works out to only Rs. 486 crore in topline for HCL - which is only 6% of its annual Nokia India sales - but the margin profiles might be much better in Middle East, whereas growth prospects might be much better in Africa. Nokia is also facing much heat in India, with market shares slipping from around 60% to 50% over the last year.
In fact, the almost free-fall that the scrip witnessed in the year-to-date was a kind of gradual discounting the market was doing in anticipation of the contract expiry. But the recent significant recovery from its 52-Week Low of Rs. 83.50 recorded on 26th November, signals that at least a section of the market had started anticipating that HCL Infosystems would come up with some kind of a breather regarding Nokia, which has now happened, however, in an unanticipated way.
More importantly, the move shows that HCL Info is keen to prolong and extend its partnership with the handset major, even though many of Nokia's recent India strategies had affected HCL's fortunes adversely. A case in point is Nokia's long reluctance to come up with dual-sim phones, which was corrected only recently. However, the current Middle East deal has all of Nokia's blessings.
HCL Infosystems which took birth as a computer manufacturer has been beleaguered in its original business too, even though it still leads in the desktop segment of the country. But this status can increasingly become irrelevant, as India is rapidly moving to laptops and netbooks, if not the new segment of mobile Pads, and HCL Info's mobile computing brands haven't been able to break into the Top-3 league of Acer, HP, & Dell. The lackluster performance on this front is very disappointing, as HCL Infosystems almost has double the PBIT margins from this business as compared with the Nokia distribution.
Perhaps foreseeing all these, HCL Info had from long back started to strengthen its services business, especially its system integration (SI) segment. Though the order book in SI is quite good now, the actual numbers for the service segment in the year ended June 2010 shows that it is hovering around 6% only. But there is hope on this front as the services segment has been growing at above 10% annually for the company, with the profits from services growing even faster.
Coming to the valuation front, HCL Infosystems is attractively available compared to peers like CMC, Redington, or even a not-so-fully comparable Spice Mobility. Both by price-earnings and price-to-book-value, HCL Info is available at a steep discount to such peers. With a P/E of just over 10 and a P/BV of just 1.36, HCL Info looks definitely safer than peers who trade above P/E of 25, and P/BV of 4, 8, or more.
One reason might be that CMC and Spice have much better margin profiles, but still, there is no reason why HCL Infosystems can't trade near Redington's valuations, in the coming years, if not quarters. But for that to happen, the Nokia overhang should clear out favourably. That can present a significant upside, of almost 100% price appreciation from current levels.
It would be also worthwhile to watch the company quarter-to-quarter to ascertain whether their long-term vision of using the distribution channels for multiple products, their focus on system integration, and their overseas expansions both in the distribution and services space are growing as intended.
HCL Infosystems which got a new CEO in October, is also a signal of the transformations planned by the IT major. Though it would be premature to compare Harsh Chitale with a team-builder like HCL Technologies' Vineet Nayar, the new CEO's specific track-record in creating inorganic growth in Honeywell and cracking developed markets like US should help. The recent acquisition might be a reflection of these newfound traits in the organization.
Already it is using the distribution channels to push products from Apple, Nintendo, & former partner HP, but significant momentum is still to build up. Earlier, HCL Info had bought 60% stake in another Dubai based company, NTS Group, which is into IT Services & Solutions.
Though the company had announced the Techmart deal during trading hours, markets didn't respond very enthusiastically. However, this can change in the coming trading sessions, and it looks like HCL Infosystems can scale a short-term target of Rs. 130, if nothing very adverse happens on the Nokia India front or the capital markets in general. However, both the short-term and long-term downsides seem capped at only Rs. 80 levels, and investors should be willing to apply stop-loss if the stock breaches immediate support levels of Rs. 112 or Rs. 105, or average deep down at Rs. 80 levels.
The scrip should be watched closely for news flow and analysis, as much upside is possible on fundamental improvements, especially so since, then even its 52-Week High won't look terribly expensive. The key factor for now remains how the Nokia India deal pans out.
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