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HCL Infosystems
Increasing headwinds
We see near-term headwinds to HCLI’s SI business due to execution delays and
Nokia’s volumes expected to be under pressure. We lower our FY11/12F EPS
12%/11%. Consensus downgrades should follow, but a 7% dividend yield and
strong order book give some comfort of a back-ended recovery. Hold, from Buy.
Downgrading to Hold on SI/handset business headwinds
We believe a general slowdown in decision making in the public sector has negative
implications for HCLI’s System Integration (SI) business, which executes large turnkey
contracts in this space. We believe HCLI derives 75-80% of revenues from such projects
and, hence, such a slowdown could have a material impact. We lower SI revenue forecasts
for FY11/12 by 34%/23%. We also see Nokia continuing to lose market share in a period of
transition to Window Mobile OS from Symbian, when new product introduction could slow
down. Our channel checks confirm that the competition has caught up on product breadth
and is aggressively ramping up distribution, key areas of strength for Nokia historically. We
lower our FY11/12F domestic handset revenues by 3%/7% to reflect these challenges.
Longer-term picture looks better, given the order book strength
We believe on a long-term basis, the SI business has good growth potential, given a large
order backlog (4.1x LTM revenues) and the opportunities available in the domestic SI space.
Nokia’s commitment to increase the pace of innovation to compete with the Asian white label
ecosystem bodes well in the medium term for the introduction of new products. Overseas
expansion and learning are longer-term growth drivers, though they are at a small base now.
Dividend yield provides support, we anticipate opportunities to enter at lower prices
We lower our EPS forecasts for FY11/12F by 12%/11%, building in slippage in SI execution
and the handset business. We see downgrades to earnings forecasts, particularly on FY11F
EPS, where we are now about 14% below Bloomberg consensus estimates. We believe,
given the weak earnings outlook for the remainder of FY11 (June-end), there will be
opportunities to enter the stock at lower levels, despite a 7% dividend yield. A key event risk
for HCLI is the review of the distribution contract with Nokia by August 2010 (with potential
upside/downside implications).
Increasing headwinds
We expect System Integration (SI) revenues to slow from the reduced pace of execution on
large government/public sector projects. Meanwhile, the distribution business remains
challenged by Nokia’s market share loss.
System Integration – 2HFY11 could see execution slippages
We expect a general slowdown in decision making in the public sector, to have a material impact
on HCLI’s SI business in 2HFY11. Sign-off of milestones in government/public sector projects are
getting delayed, due to the exposure of a number of corruption scandals, making the bureaucracy
wary of taking quick decisions. We believe about 75-80% of HCLI’s current order book (Rs42bn)
comes from such projects. Most of these contracts have several milestone-based revenue
accruals, and hence delays could immediately impact the SI business.
We also note that a lot of HCLI’s incremental order book comes from long-gestation projects, like
the MP-Public distribution order (seven-year BOT) and digitising processes of a municipal
corporation. Hence, we expect revenue from such projects to be spread of a long period of time,
even if the decision making becomes normalised. In absolute terms, we now expect FY11 SI
revenues to be 22% below FY10 levels (versus our earlier expectation of 18% growth). This
comes on the back of modest 3.3% yoy growth in FY10.
We lower SI revenue forecasts by 34%/23% for FY11/12. As a result, our computer systems
revenue forecasts are down by 8%/6% for FY11/12F. Given that the SI business is at relatively
higher margin compared to hardware, this also results in a 48bp/29bp lower EBITDA margin
forecast for the segment.
Over the longer term, we remain positive on SI business growth. The ratio of pending order book
to TTM sales is fairly high, at 4.1x in 2Q11. We expect revenues from large transformational
projects to start kicking in from the second half of FY12, putting growth back on track.
Handset business – channel checks continue to point to continued market share erosion
Nokia’s market share loss over the past few quarters is well documented. We believe things could
get worse before they get better. We believe the company has been clearly struggling relative to
Indian brands at the low end, while a resurgent Samsung offers a wide variety of mid-range
products. On the other hand, the envisaged transition of handset operating system from Symbian
to Windows Mobile poses a medium-term challenge to the high-end portfolio.
Historically, Nokia’s market share dominance has been underpinned by two factors – the ability to
offer the widest range of products spanning price points, and the distribution reach, which has
been unparalleled. We believe on both counts Nokia is losing out to the competition.
Our recent channel check with dealers indicates that Nokia’s rate of product introduction,
particularly in the low-mid range has slowed considerably. We believe the number of models now
actively sold by dealers has come down to about 20 compared to more than 30 a few quarters
ago. Comparatively, we believe Samsung offers a wider variety of handsets competing across
price points and features.
Table 1 : Number of models available with a leading handset retail chain in Mumbai
Brand # of models
Samsung 35
Nokia 20
LG 12
Micromax 10
Motorola 8
Spice 7
Blackberry 5
HTC 5
Karbonn 5
Note: The chain sells only running models, with minimum warranty period of 1 year
Several other Indian branded models are not sold by the retailer
Source: RBS research
At the lower end, players like MicroMax and Spice continue to offer handsets with differentiated
features (dual-sim being the most obvious). Over the past couple of years, these companies have
invested considerably in branding and product innovation, thereby considerably improving their
brand image. We believe challenges at the higher end are also equally daunting. Nokia
management has committed to a transition from Symbian to Windows Mobile OS. With the
Symbian roadmap having a limited life, we believe customer preferences are likely to turn away
from Nokia to competitors, while Nokia management expects Windows Mobile OS-based Nokia
phones to be available in the market only in 2012.
We also believe the competition has considerably bridged the gap with Nokia on the distribution
front. Competitors are penetrating deeper, particularly in tier-three cities and small towns, where
Nokia was previously dominant. Also, Indian brands that started with a few states have now plans
to go national. For instance, Spice Mobiles plans to expand from five states in North India to 24
states and increase retail outlet coverage by 4x over the next 15 months.
Table 2 : Number of points of sale outlets for various mobile handset brands
Brand # of outlets
Nokia (March 2011) 200,000
Samsung (Feb 2011) 70,000
Micromax (Mar 2011) 75,000
Spice (Oct 2010) 50,000
Source: Company data , Media reports
Nokia management has committed to increasing the pace of innovation, particularly to combat the
Asian white-label ecosystem. We believe the efforts should bear fruit some time down the line,
given the head-start that the competitors have. Hence, we expect stability in volumes only post
the launch of a dual-sim phone, which we believe could happen toward the latter part of 2011,
based on our channel checks.
HCLI also bought a 20% stake in TechMart Telecom, a high-end Nokia handset distributor for the
Middle East & North Africa (Mena) region. We believe this business will also be challenged in
terms of ramp up, given that the high-end portfolio remains most exposed to competition from
Apple and Andriod OS, while the shift from Symbian to Windows Mobile OS will likely result in the
product portfolio being scanty in the interim.
We lower domestic handset distribution revenue handset forecasts by 3%/7% for FY11/12 and
TechMart revenue forecasts (20% consolidated into HCLI’s books) by 35%/20% for FY11/12.
Overall our telecom/office automation (OA) revenue forecasts are lower by 4%/7% for FY11/12.
Downgrade to Hold
We lower our FY11/12F EPS by 12%/11%, building in lower System Integration and handset
distribution revenues. We expect earnings downgrades to follow, and believe there will be
opportunities to enter at lower price levels. We downgrade to Hold.
Reducing EPS forecasts by 11-12%; Downgrade to Hold
We lower our revenue forecasts by 5%/6% for FY11/12, building in 3%/7% lower domestic
handset distribution revenues and 34%/23% lower SI revenues. Our consolidated EBITDA
forecasts are down by 12%/8% and EPS forecasts down by 12%/11% for FY11/12. We lower our
one-year forward DCF-based valuation to Rs112 (Rs120 previously), building in our lower EPS
forecasts. We expect consensus downgrades to follow on the back of weak 3Q11 results – RBS
FY11F EPS is now 13.5% below Bloomberg consensus.
We use a DCF-based valuation for HCLI, using a WACC of 14.9%, which builds in a risk-free rate
of 8% to arrive at a target price at Rs112 (Rs120 previously). Our target price implies a valuation
of 9.4x FY11F EPS. With near-term earnings headwinds, we believe there will be opportunities to
buy the stock at lower price levels. Hence we downgrade to Hold. However, we expect a backended
recovery in FY12, given strong order book and a potential slowdown in handset volumes.
The 7% dividend yield also provides some cushion at current levels
Risks to our target price
Key downside risks to our rating and target price are: 1) changes in the contracts with various
reselling partners, including Nokia (whose contract comes up for review in August 2011); 2)
increased competition, impacting market share beyond our estimates; 3) a faster-than-expected
slowdown in mobile subscriber growth, which could impact handset sales; 4) a slowdown in the
Indian economy (which could affect both enterprise and retail demand); 5) lower-than-expected
revenues/profitability of the new ventures such as Learning and Overseas Distribution; and 6)
rupee depreciation, which would raise the import costs of key hardware components.
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
HCL Infosystems
Increasing headwinds
We see near-term headwinds to HCLI’s SI business due to execution delays and
Nokia’s volumes expected to be under pressure. We lower our FY11/12F EPS
12%/11%. Consensus downgrades should follow, but a 7% dividend yield and
strong order book give some comfort of a back-ended recovery. Hold, from Buy.
Downgrading to Hold on SI/handset business headwinds
We believe a general slowdown in decision making in the public sector has negative
implications for HCLI’s System Integration (SI) business, which executes large turnkey
contracts in this space. We believe HCLI derives 75-80% of revenues from such projects
and, hence, such a slowdown could have a material impact. We lower SI revenue forecasts
for FY11/12 by 34%/23%. We also see Nokia continuing to lose market share in a period of
transition to Window Mobile OS from Symbian, when new product introduction could slow
down. Our channel checks confirm that the competition has caught up on product breadth
and is aggressively ramping up distribution, key areas of strength for Nokia historically. We
lower our FY11/12F domestic handset revenues by 3%/7% to reflect these challenges.
Longer-term picture looks better, given the order book strength
We believe on a long-term basis, the SI business has good growth potential, given a large
order backlog (4.1x LTM revenues) and the opportunities available in the domestic SI space.
Nokia’s commitment to increase the pace of innovation to compete with the Asian white label
ecosystem bodes well in the medium term for the introduction of new products. Overseas
expansion and learning are longer-term growth drivers, though they are at a small base now.
Dividend yield provides support, we anticipate opportunities to enter at lower prices
We lower our EPS forecasts for FY11/12F by 12%/11%, building in slippage in SI execution
and the handset business. We see downgrades to earnings forecasts, particularly on FY11F
EPS, where we are now about 14% below Bloomberg consensus estimates. We believe,
given the weak earnings outlook for the remainder of FY11 (June-end), there will be
opportunities to enter the stock at lower levels, despite a 7% dividend yield. A key event risk
for HCLI is the review of the distribution contract with Nokia by August 2010 (with potential
upside/downside implications).
Increasing headwinds
We expect System Integration (SI) revenues to slow from the reduced pace of execution on
large government/public sector projects. Meanwhile, the distribution business remains
challenged by Nokia’s market share loss.
System Integration – 2HFY11 could see execution slippages
We expect a general slowdown in decision making in the public sector, to have a material impact
on HCLI’s SI business in 2HFY11. Sign-off of milestones in government/public sector projects are
getting delayed, due to the exposure of a number of corruption scandals, making the bureaucracy
wary of taking quick decisions. We believe about 75-80% of HCLI’s current order book (Rs42bn)
comes from such projects. Most of these contracts have several milestone-based revenue
accruals, and hence delays could immediately impact the SI business.
We also note that a lot of HCLI’s incremental order book comes from long-gestation projects, like
the MP-Public distribution order (seven-year BOT) and digitising processes of a municipal
corporation. Hence, we expect revenue from such projects to be spread of a long period of time,
even if the decision making becomes normalised. In absolute terms, we now expect FY11 SI
revenues to be 22% below FY10 levels (versus our earlier expectation of 18% growth). This
comes on the back of modest 3.3% yoy growth in FY10.
We lower SI revenue forecasts by 34%/23% for FY11/12. As a result, our computer systems
revenue forecasts are down by 8%/6% for FY11/12F. Given that the SI business is at relatively
higher margin compared to hardware, this also results in a 48bp/29bp lower EBITDA margin
forecast for the segment.
Over the longer term, we remain positive on SI business growth. The ratio of pending order book
to TTM sales is fairly high, at 4.1x in 2Q11. We expect revenues from large transformational
projects to start kicking in from the second half of FY12, putting growth back on track.
Handset business – channel checks continue to point to continued market share erosion
Nokia’s market share loss over the past few quarters is well documented. We believe things could
get worse before they get better. We believe the company has been clearly struggling relative to
Indian brands at the low end, while a resurgent Samsung offers a wide variety of mid-range
products. On the other hand, the envisaged transition of handset operating system from Symbian
to Windows Mobile poses a medium-term challenge to the high-end portfolio.
Historically, Nokia’s market share dominance has been underpinned by two factors – the ability to
offer the widest range of products spanning price points, and the distribution reach, which has
been unparalleled. We believe on both counts Nokia is losing out to the competition.
Our recent channel check with dealers indicates that Nokia’s rate of product introduction,
particularly in the low-mid range has slowed considerably. We believe the number of models now
actively sold by dealers has come down to about 20 compared to more than 30 a few quarters
ago. Comparatively, we believe Samsung offers a wider variety of handsets competing across
price points and features.
Table 1 : Number of models available with a leading handset retail chain in Mumbai
Brand # of models
Samsung 35
Nokia 20
LG 12
Micromax 10
Motorola 8
Spice 7
Blackberry 5
HTC 5
Karbonn 5
Note: The chain sells only running models, with minimum warranty period of 1 year
Several other Indian branded models are not sold by the retailer
Source: RBS research
At the lower end, players like MicroMax and Spice continue to offer handsets with differentiated
features (dual-sim being the most obvious). Over the past couple of years, these companies have
invested considerably in branding and product innovation, thereby considerably improving their
brand image. We believe challenges at the higher end are also equally daunting. Nokia
management has committed to a transition from Symbian to Windows Mobile OS. With the
Symbian roadmap having a limited life, we believe customer preferences are likely to turn away
from Nokia to competitors, while Nokia management expects Windows Mobile OS-based Nokia
phones to be available in the market only in 2012.
We also believe the competition has considerably bridged the gap with Nokia on the distribution
front. Competitors are penetrating deeper, particularly in tier-three cities and small towns, where
Nokia was previously dominant. Also, Indian brands that started with a few states have now plans
to go national. For instance, Spice Mobiles plans to expand from five states in North India to 24
states and increase retail outlet coverage by 4x over the next 15 months.
Table 2 : Number of points of sale outlets for various mobile handset brands
Brand # of outlets
Nokia (March 2011) 200,000
Samsung (Feb 2011) 70,000
Micromax (Mar 2011) 75,000
Spice (Oct 2010) 50,000
Source: Company data , Media reports
Nokia management has committed to increasing the pace of innovation, particularly to combat the
Asian white-label ecosystem. We believe the efforts should bear fruit some time down the line,
given the head-start that the competitors have. Hence, we expect stability in volumes only post
the launch of a dual-sim phone, which we believe could happen toward the latter part of 2011,
based on our channel checks.
HCLI also bought a 20% stake in TechMart Telecom, a high-end Nokia handset distributor for the
Middle East & North Africa (Mena) region. We believe this business will also be challenged in
terms of ramp up, given that the high-end portfolio remains most exposed to competition from
Apple and Andriod OS, while the shift from Symbian to Windows Mobile OS will likely result in the
product portfolio being scanty in the interim.
We lower domestic handset distribution revenue handset forecasts by 3%/7% for FY11/12 and
TechMart revenue forecasts (20% consolidated into HCLI’s books) by 35%/20% for FY11/12.
Overall our telecom/office automation (OA) revenue forecasts are lower by 4%/7% for FY11/12.
Downgrade to Hold
We lower our FY11/12F EPS by 12%/11%, building in lower System Integration and handset
distribution revenues. We expect earnings downgrades to follow, and believe there will be
opportunities to enter at lower price levels. We downgrade to Hold.
Reducing EPS forecasts by 11-12%; Downgrade to Hold
We lower our revenue forecasts by 5%/6% for FY11/12, building in 3%/7% lower domestic
handset distribution revenues and 34%/23% lower SI revenues. Our consolidated EBITDA
forecasts are down by 12%/8% and EPS forecasts down by 12%/11% for FY11/12. We lower our
one-year forward DCF-based valuation to Rs112 (Rs120 previously), building in our lower EPS
forecasts. We expect consensus downgrades to follow on the back of weak 3Q11 results – RBS
FY11F EPS is now 13.5% below Bloomberg consensus.
We use a DCF-based valuation for HCLI, using a WACC of 14.9%, which builds in a risk-free rate
of 8% to arrive at a target price at Rs112 (Rs120 previously). Our target price implies a valuation
of 9.4x FY11F EPS. With near-term earnings headwinds, we believe there will be opportunities to
buy the stock at lower price levels. Hence we downgrade to Hold. However, we expect a backended
recovery in FY12, given strong order book and a potential slowdown in handset volumes.
The 7% dividend yield also provides some cushion at current levels
Risks to our target price
Key downside risks to our rating and target price are: 1) changes in the contracts with various
reselling partners, including Nokia (whose contract comes up for review in August 2011); 2)
increased competition, impacting market share beyond our estimates; 3) a faster-than-expected
slowdown in mobile subscriber growth, which could impact handset sales; 4) a slowdown in the
Indian economy (which could affect both enterprise and retail demand); 5) lower-than-expected
revenues/profitability of the new ventures such as Learning and Overseas Distribution; and 6)
rupee depreciation, which would raise the import costs of key hardware components.
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