BPO will come back to HCL margins after 2012: Nayar

HCL Technologies, India's fourth-largest software services exporter, reported a 28% rise in quarterly net profit, beating expectations, after customers boosted orders to cut operational costs amid the global economic uncertainty.

Consolidated net profit for the fiscal third quarter ended March 31 rose to Rs 600 crore from Rs 468 crore a year earlier, the company said on Wednesday.
HCL follows a July-June fiscal year. Sales rose 26% to Rs 5216 crore.
Speaking to CNBC-TV18, Vineet Nayar, vice chairman and CEO of HCL Tech said the company has signed USD 2.5 billion worth of deals in the last six months, out of which USD 1.4 billion came from North America.
Analysts had forecast a net profit of Rs 574 crore for the company, whose customers include Xerox Corp and Readers Digest Association Inc, according to Thomson Reuters Starmine data.
HCL Tech plans on focusing on the execution of large deals in the near-term, Nayar said adding, "the realisations will remain more or less flat in Q3."  
Meanwhile, Anil Chanana, CFO of HCL Tech said the margin improvement is coming from operation efficiencies. "The move to merge financial services with our BPO business has paid rich dividends," he explained. 
However, Nayar added that BPO margins will remain at break even levels and will come back to HCL margins only after the current calendar year. "Now is not the time for booking but for good execution," he said. Below is the edited transcript of the HCL Tech management's exclusive interview on CNBC-TV18. Also watch the attached videos. Q: Your dollar revenues are up 2.5% in a quarter when Infosys dollar revenues were down by 2% and that lead to a lot of consternation on the sector. Do you expect to see such disparity in performances going forward and is this the sign of changing market shares that you were alluding to earlier? Nayar: I can talk about what I can see from my vantage point of view. It is difficult to comment on others. I had alluded to the fact that we would see some very large deals happening in the market space in medium term. So in the last two quarters we saw USD 2.5 billion plus signature by HCL predominantly because there were a lot of ventures which were happening. I see significant slowdown on those large deals and therefore we would focus on execution of the current deals. The growth rates of the respective companies would depend upon whether they are focused on this segment, whether they are on the gaining side of this churn or they are on the losing side. I think that will determine different commentaries for different companies across the world. Q: But broadly speaking do you think the 11 to 14% NASSCOM guidance still holds? Because you are part of that sector as well and that came into question with the second largest player in the segment saying they will grow only 8-10%. What is HCL Tech’s commentary on what NASSCOM has guided for the year given the kind of trends that you are seeing? Nayar: I do not know what laws of averages mean predominantly because the overall IT spends is flat to negative. Therefore you can only win by gaining market share which is what HCL is doing. The commentary from HCL is more optimistic than some others. The way I see it is the profit pool in the US companies is the highest ever; it is about 20% higher than what it was pre-recession. The capital expenditure is lower by 1% but they are still investing. So, most of the companies are changing their vendors because they want to reduced costs of run-the-business, and reinvest and change the business.
Therefore if you are a company which helps them reduces the run-the-business and also taking that saving in form of change the business which is what we are doing if you look at the enterprise application growth in the last two quarters of 4% each. So if you are doing both in terms of reduce run-the-business and change the business you would see growth in America.
If you come to Europe, because of the fact there is lot of first time out sources coming in because their profit pool is at historical low levels and therefore there is panic reaction there of reducing costs. There is lots of first time out sourcing companies coming in. Therefore if you have invested in the market with the right proposition and they are lot more careful about out sourcing than America then you will win in that market. So it really depends upon how do you see the market and how you are aligning your limited resources in the markets which are perfuming and if we do that, I see no reason why growth should not happen. Q: Having said that there are some worry points, first flagged by Infosys when they announced results and even in your numbers the BFSI (the banking, financial services and insurance) segment is not looking very healthy and North America has some wrinkles. Are there some pressure points building up in that specific geography and that vertical?
Nayar: I think that’s a very important point which you are raising. North America is a wrinkle and if you look at the last four quarters the financial services has been going through a structural change from a high margin industry to a lower margin industry and therefore existing clients are squeezing their chains in business projects till they are able to squeeze or run the business budget and reinvest back and change the business. So that is one lens to see what is happening in the financial services industry.
The second lens to see which is more interesting is that we have signed billion dollars worth of deals in the financial services in US and Europe in the last six months that means HCL is on the winning side of a lot of vendor consolidation and therefore financial services which actually will be a significant growth area for HCL and which I think it will outperform the company average growth rate.
Coming to North America on the last 12 months basis North America has grown at about 19%. If you remove this quarter, this quarter in an aberration but North America USD 1.4 billion deal which we have signed in North America, will also contribute significantly to the growth of the company. So my commentary in financial services is that they have restructured themselves over the last 4 quarters because of which vendor consolidation happened, HCL won a substantial part of it therefore it will grow same as North America. Q: EBIT margins slipped just a little in the current quarter, just take us through what happened in the quarter gone by and whether you can get EBIT margins substantially above 15%, maybe even 16% during the course of the year? Chanana: What has happened is for the last two consecutive quarters we have been having a higher EIBTDA as well as EBIT margins. The margins this quarter in spite of the currency headwind of 90 basis points has stayed flat, which means it has come through operating efficiencies. So the margin trajectory for HCL Tech in the last two quarter has been positive. So as far as future is concerned, we will refrain from giving any guidance, Q: On the margin front two specific questions. What was happening on the pricing front and also on the utilization front given that some of your peers have reporting fairly low utilization levels? Chanana: We have been forming a much differentiated strategy in terms of hiring. Last year April-June quarter we decided to take-in freshers, train them and we keep them ready as and when business come in our door. So the business in our door and we will use them. At the same time in that period we have been using the laterals, as part of our just-in-time hiring. So we will continue to follow that strategy. As a result of which you see an improvement in utilization. A slight improvement in utilization in offshore but as far as the onsite is concerned, it is marginally down.
The realizations have been flat, a very small improvement but I would call it flat not as any significant margin flowing out of that realization. IT is basically out of operating efficiencies that is margin improvement. Q: The silver lining in the quarter or the star in the quarter has been infrastructure management services again after couple of relatively sluggish quarters. Is that business picking up again? Nayar: Yes, it is picking up; they clocked in a billion dollar deals also this quarter. However the dark horse which is going unnoticed is the enterprise applications. For the last two quarters they have grown by about 4.3 and 4.6% sequentially in a very tough market and if you only look at six months then enterprise applications has outperformed all other service lines within HCL. In terms of the growth it is not just about run the business; you can enter the account and run the business but how effectively do you take the savings originated from run the business and change the business. So enterprise application growth is a reflection of the fact that not only we enter the account with application support or infrastructure management but we are able to convert the savings and change the business for enterprise applications and for R&D very effectively. Therefore in my mind the real growth story is the enterprise application for the last two quarters. Q: BPO broke even in the current quarter, turned EBIT neutral. Where from here on that business? Nayar: I said that it would because we are following a very methodical strategy of redoing the BPO. I think merging financial services and BPO under one team is paying rich dividend and therefore you saw a signing about USD 500 million in BPO and about billion dollars in financial and services in the last six months. I think going forward over this calendar year BPO will remain breakeven because we still have some restructuring to do.
Some we have announced, some we will announce but this calendar year you would expect BPO to a) grow, b) remain breakeven and then over a period of years BPO will come back to HCL normal margins because as all the new contracts they are signing is as HCL margins as all the old contracts we are either shutting them down or we are slowly getting out of them. So as the mix changes the margins will improve over a period of time. That is exactly what happened in infrastructure and services.
They went from 8 to 16. I also think BPO will go from breakeven to company specific margins and it is a matter of couple of years. Q: I heard you earlier say that having done very well in the last couple of quarters in terms of deal wins. Now things will begin to slowdown. That is important in the context of your stock performance because since the start of the year you have been the standout stock in the frontline IT space. Are you saying now that level of outperformance might begin to ebb off a bit because you will not be able to beat your peers with performance or now with execution dollar revenue performance will still be industry beating thus that the order intake will slowdown? Nayar: I think what has happened is we have never historically seen USD 1.5 billion in a quarter, we have never historically seen USD 2.5 billion in six months. So historically we are way ahead of the curve and now is the time to go in for more booking but execute and convert this booking into revenue. So that is what I was alluding to. We are a small company; USD 4 million doesn’t make us big compared to IMB and Accenture and therefore it is important to spread your dollars in areas which matters most.
For the last six months I have been saying that the window of opportunity is large, go in and get into this fortune 500 customers. So 88% of our win which is 2.1 billion is fortune 500. Now we have to execute well. So what we are going to focus now is modern booking, so you will not see deal announcements coming from HCL for the next 1-2 quarters you will see again in October-November-December of ’12. We are going to put all our management attention and our dollars in executing what we have won and creating a wow for the customers so that we can cross sell and up sell but growth will still happen.
It is just a matter of shipping from booking to billing and cross selling and up selling, which is a cycle we have always followed. If you go back to what I said in October-November-December of ’08 we booked and then we cross sold and up sold. So same with '09; we booked and then we focused on cross sell and up sell. We have limited dollars in sales and marketing and it is very important to move that dollar around so that we get maximum output for the investment.