HCL Reports Strong Sequential Growth:: Wells Fargo

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Offshore: HCL Reports Strong Sequential Growth
Europe Leads Growth In the Quarter; Current Deal Flow Strong
Confirms Positive Demand Trends For Offshore IT Market



• Summary: #5 Offshore Provider HCL Reports Strong Sequential
Revenue Growth; Confirms Positive Market Trends for Offshore
Providers. India-based offshore provider HCL Technologies (trades in India)
reported 9.0% q/q revenue growth (7.4% in cc) and offered positive commentary
on improved demand from Continental Europe. BPO (up 5.7% q/q) grew
sequentially for the first time in four quarters. Although indicating that U.S.
clients are investing out of "hope" and European clients out of "fear", we viewed
management tone as positive. While others have reported sustained strong
operating margin, HCL's is expected to be under pressure as it steps up
investments to meet the improving demand picture. The company aggressively
added employees (particularly laterals) for the past two quarters as FY11-12
growth is expected to be well above that of FY09-10. BOTTOM-LINE: we view
HCL's report as consistent with prior comments from Infosys (INFY), particularly
regarding strength in Continental Europe and broad-based demand
improvement. We believe IT demand is stronger than BPO, and view this as
another positive data point for offshore IT providers, particularly Outperformrated
Cognizant (CTSH).
• Q/Q Revenue Growth Accelerates; Margin Down on SG&A and
Utilization. Revenue increased 28% yr/yr and 9.0% q/q (7.4% in cc) with
growth being strongest in software services (9.3% q/q) and infrastructure services
segments (8.9%), while BPO lagged (5.7%). Operating margin declined for a 4th
consecutive quarter, driven by increased hiring/reduced utilization. Over the past
two quarters, HCL has added 10,736 net employees leading to ~600bp decline in
offshore utilization, increased SG&A to win new deals, and increased wages. HCL
expects SG&A to increase to ~16% of revenue next quarter, but operating margin
expected to be flat before improving in FQ4 on a constant currency basis.
• Retail/CPG and Continental Europe Led Growth. By vertical, sequential
growth was strongest in retail/CPG, up 13% q/q (11.2% in cc), and led by CPG,
where HCL noted significant vendor turnover and consolidation. By geography:
growth in Europe (18.3% q/q, 13.4% in cc) was well above the Americas (2.8% q/q
and in cc), led by Continental Europe. In the Americas, deals are largely
transformational, while in Europe, demand is driven by a need to rationalize and
reduce costs. In Asia, clients are investing in IT to facilitate globalization.