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HCL Technologies to buy IBM software products in $1.8 billion deal

Shares of Indian software developer slumps amid concerns about purchase price

As part of the deal, HCL will buy from IBM seven standalone software products that service a range of clients in the marketing, security, and commerce sectors.  (Photo by Ken Kobayashi)

MUMBAI (NewsRise) -- HCL Technologies agreed to buy select software products from International Business Machines for $1.8 billion, a deal that raised concerns among investors whether it will pay off.

As part of the deal, HCL will buy from IBM seven standalone software products that service a range of clients in the marketing, security, and commerce sectors, gaining access to 5,000 customers across the world, the Indian company said in a statement on Friday. "The products that we are acquiring are in large growing market areas which are strategic segments for HCL," said C. Vijayakumar, president and chief executive of the software exporter. Shares of HCL Technologies closed down 5%, its biggest fall in seven weeks, in Mumbai trading on Friday. The benchmark S&P BSE Sensex gained 1%.

HCL, backed by Indian billionaire Shiv Nadar, has over the past two years stitched up licensing agreements with IBM for five of these seven products worth $1.2 billion. The latest deal will give the company access to opportunities worth $50 billion in different markets and enhance its reach to sell other core services.

In a conference call with analysts, CEO Vijayakumar said some of the products are "cash cows," while some are "going to grow because of the momentum in the market." Still, some products "will need infusion of fresh life to make it grow in line with the market."

The deal will give HCL access to 5,000 customers across sectors in various parts of the world, a feat it would have taken 20 years to achieve on its own, he said.

Still, analysts remain wary of the price of the purchase.

"The deal demonstrates HCL's aggressive focus on transition to platform and product-led solutions," Edelweiss Securities said in a report. The "total investment of $3 billion appears high, especially due to limited information on revenue cannibalization and amortization."

The company declined to give further details on the revenue layovers between the earlier licensing partnership with IBM and the latest deal.

The acquisition will help HCL bulk up its revenue run-rate by $625 million per annum in the year after the close of the transaction and $650 million from the second year. The operating margins will have a run-rate of over 50%. The deal is likely to be closed by mid next year.

HCL expects the new products to expand its cash earnings per share 15%.

The declining revenue of some of these products over the past several quarters is also a concern.

"At a portfolio level, we reckon the products portfolio not to outperform the legacy portfolio," Ambit Capital said in a note. "It goes without saying the some of the products being acquired are at the fag-end of their growth cycle."

The acquisition comes as HCL is struggling to spur growth in its core infrastructure management business as clients move their technology infrastructure to cloud computing.

IBM is betting on the hybrid cloud market business that offers software and services on the internet as it exits the slowing services business. The company is making a $34 billion acquisition of Red Hat, an open source technology company, to enhance its presence in the cloud business.

"The time is right to divest these select collaboration, marketing and commerce software assets, which are increasingly delivered as stand-alone products," John Kelly, a senior vice president at IBM, said in the statement.

--Dhanya Ann Thoppil

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