HCL’s software products business falls short of profitability expectations

HCL Technologies had bought the eight products from IBM in December 2018 for $1.8 billion (the acquisition was completed in July 2019), the largest purchase by an IT services company at the time, and marking a rare incursion by any Indian service provider into the highly competitive software products arena.

But profitability of the unit, rebranded HCLSoftware in June 2022, has been falling each year since the IBM transaction barring FY23 (see chart). It has also not matched expectations. The company’s target profitability of 30% for software products, which it had outlined in a presentation after the IBM deal, has been met only once, in FY20, according to a Mint analysis.

To be sure, in FY24, the operating margin of the software products business was much higher at 24.7% than its overall operating margin of 16.9% (for HCL’s core IT and business services vertical). On the other hand, operating margins of the IT and business services vertical, too, fell in the four fiscal years through FY24, but at a much lower 80 basis points.

“The margins for HCLSoftware were unusually higher in the first two years as most of the revenue flowed in from IBM-inked contracts and it took us time to make the required investments in sales and marketing as well as getting new versions ready,” HCL Technologies’ spokesperson said in a written response to Mint’s email.

“Profitability in HCLTech’s software business has been impacted by volatility in perpetual licence upfront, which is the software licence fees mostly for on-premise software,” said Apurva Prasad, vice-president of institutional research at HDFC Securities.

The revenue angle

Omkar Tanksale, research analyst at Axis Securities, pointed out that revenue for the software products business has increased and HCLTech’s brand value will allow that business to grow.

“HCLTech finds it easier to sell its software products to clients across major industries because of its presence in those industries and the efficiency the IT company can provide,” said Tanksale, adding that the IT company finds it easier to provide a software product with minor changes based on each client’s industry needs.

Revenues of the software products business, headed by Kalyan Kumar who took over as the chief product officer of that unit in May 2022, clocked a compounded annual growth rate (CAGR) of 5.48% in the four years since March 2020, exceeding the company’s overall revenue CAGR of 4.33% in this time.

At the same time, the company in a presentation had outlined up to $650 million in incremental revenue for the first year (FY20) since the purchase of the IBM products. However, it managed incremental revenue of $242 million that year.

“In FY20, HCLSoftware numbers does not have the full-year impact of the software product acquisitions, as the acquisition got consummated during the financial year,” the company spokesperson said.

In the following years, HCLSoftware’s incremental revenues were less than $35 million each year. In FY23, it also saw a decline in business of $18 million.

The significance of software business

The software products business keeps industry, and analysts, interested because of the potential for higher margins. Over the past 16 quarters, analysts have quizzed the HCLTech management on the products business’ revenue at least 21 times, according to Mint’s research.

“HCLSoftware has shown decent and steady low-single-digit growth in the last two years. The fact that our IT Services businesses delivered industry leading growth in FY23 and FY24 has made the percentage revenue from HCLSoftware go down on an overall basis,” HCLTech’s spokesperson said.

In FY24, HCLSoftware’s revenues of $1.4 billion was 10.5% of the company’s overall topline of $13.3 billion. The company also grew its revenues the fastest, at 5.4%, of the top four Indian IT companies in the latest fiscal gone by.

HCL Technologies had first ventured into the software products business in July 2016, when it licensed intellectual property (IP) from DXC Technology Co and IBM, so that it could build software products around these properties.