HCL Infosystems: Learning biz to be profitable next quarter

HCL Infosystems' learnings business is gaining scale and is expected to turn profitable from the next quarter, Harsh Chitale, the company's CEO said on Wednesday.

The IT hardware and systems integration company had on Tuesday announced that it would spin off its three businesses -- hardware solutions, learning and services -- into three subsidiaries. "The restructuring of the businesses is with the objective of providing focused management orientation to each of the growth areas and to create a leaner organization for the hardware solutions business," it had said. Chitale told CNBC-TV18 that there was severe stress in the hardware solutions business. The services business, meanwhile, was seeing double digit growth and the company sees significant headroom for growth there,  he added. Therefore the decision was taken to separate the operations to extract better value from each business, according to Chitale. HCL Infosystems extended gains and was up 3 percent at Rs 42.20 in morning trade. It had risen 5 percent on Tuesday. Below is the edited transcript of his interview on CNBC-TV18 Q: Take us through the highlights of the restructuring plan and why are you attempting to do something like this? A: We over last one year realized that we are operating many businesses in our one company, which have different challenges and different priorities. For example, we have a large hardware solutions business that’s going through a severe stress because of the situation that hardware industry is in. The market of hardware is not growing, it is getting commoditized, and margins are also under stress. Hence industry as a whole is in a phase of consolidation and making itself leaner. So 'making yourself lean' mindset is what the team is working on. At the same time we have large growing services business which is almost now Rs 800 crore a year which needs aggressive growth mindset. Just to give you an idea that Rs 800 crore is out of the Indian industry of almost Rs 30,000 crore of IT services. That is a phase where aggressive investing and growth mindset is needed. We also have a business of learning, which we believe is a future big bet. The headroom for growth is very big over there. Therefore, there are three different mindsets needed and we were trying to straddle all the three in one company operation. The one key requirement we realized was bringing more focus and different management perspectives to each of these three. So this was one primary driver. Second driver was, we realized that hardware and services business needs to be at arms length distance because services is a capability that we have created over last two-three decades. We have presence all over the country to service different brands of hardware. Since it was being closely tied to one brand of hardware, the capability was not getting fully leveraged. Now that the two have become arm’s length, there is a freedom for the services business to go and provide services on other competing brands of hardware, thereby unconstraining the growth of services business. Q: Your investors would want to understand the financial implications of this as well. In the first quarter you did see stress both on revenues and margins. In this reformed entity can you give us a sense of what kind of financial profile you are gunning for and what kind of revenue line the reformed entity has? A: The reformed entity is essentially about reforming our three businesses. The hardware and solutions business is about Rs 3500-4000 crore annualized business. That business in itself today is EBIT negative. That is the business which will need cost takeout and leaning actions which are already underway. Those actions are expected to be completed in three-six months time. The services business is growing in double digits with its separate identified focus. On the hardware and solutions business of Rs 3000-4000 crore, we expect cost takeout actions. That is the business which has been loosing money for us. We expect actions of almost Rs 50-60 crore of cost takeouts over next couple of quarters. On services business which is growing already at a healthy double digit, we expect that growth to accelerate further. That business is today a healthy, profitable business for us of about Rs 800 crore. As I said that business is in a market space of Rs 30,000 crore, and hence we expect significant headroom for growth with this renewed focus on services business. Q: The one criticism or concern about this learning and services line is that it has been a bit unstable in terms of its revenue performance. Can you give us a sense of what kind of quarterly run rate you expect to churn out on learning and services? A: Learning as an initiative, we started two years back. It was about Rs 23 crore in the first year, Rs 50 crore in the second year. It is now already running at Rs 100 crore annualized business. We do expect this kind of growth momentum to continue. We have been investing in building the content needed for learning and that investment phase is over. We acquired a content company six months back to give it a fillip in that effort. Hence we are moving from the investment phase to now getting this business into its profitable territory. In next quarter or two, you would see learning business itself reach its critical mass and turn to profit. Learning in India is almost Rs 150,000 crore market, with very little technology enablement there and hence headroom for growth is big. There is headroom for this Rs 100 crore business to go to Rs 500 crore, Rs 1000 crore in three-four years. At present we are reaching a critical mass that we were working towards. On the services front, some of our service deals have been lumpy. Our first focus has been in acquiring the services backlog. For example sometime back we announced one of the largest managed services win ever awarded in the country which is the Unique Identification Authority of India (UIDAI) managed services program. Now these lumpy deals come in and they are building up our total contract value (TCV) backlog of services and hence it is appearing to be lumpy. However, in terms of revenue recognition it is a healthy month on month, quarter on quarter growth of service revenue accrual that we are building. Q: A two part question, a) what kind of profitability profile the new HCL-Infosys will have, in the sense what kind of bottom-line targets you have set out for? b) whether or not you will need to infuse any cash to get these systems and businesses going and whether you will have to raise any equity in that regard? A: To answer the second part of the question, while our hardware business went through a stress, the company as a whole has been churning free cash flow at a very healthy rate. Even through the lean periods of last 12-18 months, we were generating significant amount of free cash flow. Hence, in terms of cash we are not constrained. We still have significant cash and cash equivalents on company’s balance sheet and so we do not see any need for cash infusion. This restructuring is not aimed at cash infusion or seeking any fresh equity. To answer the first part of the question on margin profile, services business operates at mid-teens in terms of its EBIT. Learning business when it reaches its critical mass is also expected to reach that kind of profit profile. Hardware solutions business however, operates in very low single digit EBIT when some of their challenges are addressed. These are the three very different margin profiles that we have in the businesses. With renewed focus, as the proportion of these healthier higher margin businesses increases,we should see margin percentage of the business go up in quarters to come.