Bengaluru Five years after Noida-based HCL Technologies bought eight software products from IBM, the company's investments in software products have not paid off as management had hoped: The business unit saw its operating margins fall by 680 basis points from fiscal 2020 to fiscal 24, despite revenue growing by $271 million during the period.
Five years after Noida-based HCL Technologies bought eight software products from IBM, the company's investments in software products have not paid off as management had hoped: The business unit saw its operating margins fall by 680 basis points from fiscal 2020 to fiscal 24, despite revenue growing by $271 million during the period.
HCL Technologies acquired eight products from IBM in December 2018 for $1.8 billion (the acquisition closed in July 2019), the largest acquisition by an IT services company at the time and a rare entry by an Indian services provider into the highly competitive software products space.
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HCL Technologies acquired eight products from IBM in December 2018 for $1.8 billion (the acquisition closed in July 2019), the largest acquisition by an IT services company at the time and a rare entry by an Indian services provider into the highly competitive software products space.
But profitability at the division, which rebranded as HCL Software in June 2022, has declined every year since the IBM acquisition except for fiscal 2023 (see chart). It's also fallen short of expectations: The 30% profitability target for software products outlined in presentations after the IBM acquisition was only met once, in fiscal 2020, according to Mint's analysis.
Indeed, the software products business's operating margin of 24.7% in FY24 was much higher than the 16.9% operating margin of HCL's overall core IT and business services division. Meanwhile, the operating margin of the IT and business services division also declined over the four years to FY24, but by a much lower level of 80 basis points.
“HCL Software's margins were unusually high in the first two years as most of its revenue came from the IBM deal and it took time to make the necessary investments in sales and marketing and to get new versions ready,” an HCL Technologies spokesperson said in a written response to Mint's email.
“Profitability of HCL Tech's software business is impacted by fluctuations in upfront perpetual licence payments, which are software licence fees, primarily for on-premise software,” said Apurva Prasad, vice-president, institutional research at HDFC Securities.
Revenue perspective
Omkar Tankar, research analyst at Axis Securities, said revenue from the software products business was growing and HCL Tech's brand value would enable that business to grow.
“HCLTech's presence in key industries and the efficiencies it can provide as an IT company make it easy for it to sell software products to clients in key industries,” Tanksale said, adding that it has become easy for it to offer software products with minor modifications based on each client's industry needs.
Revenue from the software products business, led by Kalyan Kumar, who became the division's chief product officer in May 2022, grew at a compound annual growth rate (CAGR) of 5.48% over the four years since March 2020, outpacing the company's total revenue CAGR of 4.33% over that period.
At the same time, the company outlined in its presentation that incremental revenue for IBM products would reach up to $650 million in the first year after the acquisition (FY2020). However, incremental revenue for that year was only $242 million.
“HCL Software's numbers were not impacted by the full year impact of the acquisition of software products as the acquisition was completed during fiscal 2020,” a company spokesperson said.
In the following years, HCL Software generated less than $35 million in incremental revenue each year. FY23 even saw a revenue decline of $18 million.
The Importance of Software Business
The software products business has been attracting industry and analyst interest due to the higher profit margins it offers. Over the past 16 quarters, analysts have asked HCL Tech management about the products business's revenue at least 21 times, according to Mint research.
“HCL Software has witnessed good and stable low single-digit growth over the last two years. With our IT services business delivering industry-leading growth in FY23 and FY24, the overall percentage of revenue from HCL Software has declined,” an HCL Tech spokesperson said.
HCL Software's revenue of $1.4 billion in FY24 accounted for 10.5% of the company's total sales of $13.3 billion. The company also posted revenue growth of 5.4% in the most recent fiscal year, the highest among India's top four IT companies.
HCL Technologies entered the software products business for the first time in July 2016 by licensing intellectual property (IP) from DXC Technology and IBM and building software products based on those assets.
