Company update: HCL Technologies (Neutral) - Insights into technology intangibles versus global tech

Decoding technology intangibles: Apart from IRRs of investments, HCL Technologies’ (HCLT) technology asset-oriented strategy poses 3 key challenges 1) judging the extent of their capital commitment in context with global tech companies, 2) accounting for their large intangible base, given the limited history of Indian IT companies with such strategy and 3) balance sheet centric investments make like-for-like PE comparability difficult, given amortisation implications. We draw a comparative study with global technology companies (Software, Internet and Services) to address these questions.

Global comparative study: We have compared HCLT with global companies across three buckets on best accounting practice for technology intangibles 1) IT services companies – Infosys, TCS, Wipro, CTSH and Accenture, 2) Enterprise (Traditional) software companies – IBM, SAP, Oracle, Microsoft and 3) New technology players – Salesforce, Amazon, Facebook. Our view: We note, most of these companies write down acquired/developed technology intangibles over 3-4 years versus HCLT, which does it for over 10+years.

HCLT’s technology carrying value shows the extent of capital commitment: HCLT’s amortization schedule shows (50%+ beyond year 5) the company has committed most (82%) of its intangibles in the technology/IP bucket and not under customer contract/relationship head. Our view: On an absolute basis, HCLT’s net carrying value of technology intangibles (US$1.1bn) is higher than that of global names (ex-SAP, Amazon, Facebook and Salesforce) and the highest within our sample set as a percentage of capital employed.

Peer PE comparison difficult: The quantum of capital investment (20% of capital employed) and back ended amortisation makes PE comparison with peers difficult. As peers have limited capitalised technology assets, the impact of amortisation accounting on their EPS is limited. Our view: We believe adjusted EPS derived, based on global peers’ accounting of technology intangibles gives a like-for-like PE metric.

PE discount not wide on Non-GAAP pro forma EPS: Based on a 4-year straight line amortisation of intangibles, Non-GAAP pro forma EPS, the stock trades at 14.5x FY20E earnings – 9% discount to Infosys and at 12% premium to Wipro. Our view: We see that HCLT is not at a big discount to peers on a relative basis. We think these are fair valuations and see limited room for re-rating, unless growth accelerates. Maintain Neutral.