Magic spell

PENNY WISE

Hexaware has seen good growth in the last few quarters. But a possible fall in revenues from PeopleSoft is a concern.

The September quarter has been benign to the top three IT companies - Infosys, Tata Consultancy Services (TCS) and Wipro - which showed robust growth in both topline and bottomline.

However, look beyond the three and you would find that most second-tier companies like HCL Technologies, i-flex solutions, Polaris and MphasiS have not been as lucky, and posted lukewarm results. But amidst these, Hexaware was on a high. 
 

Going cheap?
	Price (Rs)	FY05 EPS (Rs)	FY05 P/E(x)
Hexaware	531.45	42.5	12.5
HCL Tech	363	18.1	20.05
i-flex solutions	535	37	14.3
Polaris	144	11	13.22
MphasiS	268	19	14.4

Its sequential net profit growth rate of 16.9 per cent was higher than the top three IT majors whose growth rate remained at 14-15 per cent. Hexaware has been outperforming the IT sector for some quarters now, though from a lower base. The stock has given cracker returns at the bourses, appreciating by 59.8 per cent since January 2004 to Rs 531.45.

And research houses are still upbeat on the stock. In a recent report (July 23), CLSA put a target price of Rs 1,000 in 15-24 months. Kotak Securities also put out an outperformer rating on the stock in August 2004, although with a modest 12-month price target of Rs 600.

Formed in 1992 as a privately held company, Hexaware got listed in January 2001 after being merged with Aptech's software business (when Aptech decided to separate its education and software divisions).

The company provides IT outsourcing services in the human resources arena globally. It manages IT applications and offers packaged enterprise application services such as SAP (systems application product) and PeopleSoft.

With 1,000 trained professionals, Hexaware's PeopleSoft practice is the largest among offshore peers and one of the top five globally. The company offers software solutions to four of the top 10 airlines. It is also one of the earliest entrants among Indian companies in Germany.

Tall targets
Hexaware's focus on HR IT services seems to have paid off handsomely this year. In the September quarter, revenues grew 13.9 per cent sequentially to Rs 146.19 crore, while operating profit rose 42.4 per cent.

For the nine-month period ended September 30, 2004, revenues grew 64.6 per cent and while operating profit jumped 167.5 per cent. Analysts expect the company to double its revenues over the next two years on the back of larger projects.

It has raised its revenue guidance for FY04 to $118 million, against its earlier guidance of $114 million. Net profit has also been revised to $13 million from its earlier guidance of $12.5 million.

CLSA sees a 42 per cent revenue growth CAGR over 2003-06, ahead of the industry average (25-30 per cent) and most peers. It cites factors like Hexaware's strong niche in PeopleSoft and airlines and its presence in the German market. Consensus earnings estimates for FY05 is Rs 42.5.

Hexaware presently has 25 clients above $1 million annual billing and four clients above $5 million billing, a marked improvement from a year ago, when the numbers stood at 12 and two. This smart account mining differentiates it from some of its like-sized peers, say analysts. The company has around 32 Fortune 500 clients.

Since the average age of many of these alliances is less than two years, Hexaware's relationship with these clients is set to mature with possibilities of larger repeat orders. The company has a strong order book size of around Rs 765 crore to be executed over the next five years.

It has recently bagged multi-year contracts exceeding $30 million in value, less than 20 per cent of which is related to PeopleSoft technology.

Hexaware is already the largest offshore vendor to Lufthansa Systems AG. Also, one of its major clients - Exult - was taken over by Hewitt Associates and this puts it in a position to get orders from Hewitt itself.

A blindfolded buy?
The company has seen a decisive improvement in managing expenses. Selling, general and administration (SG&A) expenses fell 260 basis points as a percentage of sales last quarter following a 160 basis-point drop in the previous quarter.

However, the worry is that these expenses still account for 21.5 per cent of revenues (much higher than the industry average of 15 per cent).

There are certain other issues as well. The company's top client contributes 13.4 per cent of its quarterly revenues and top 10 clients constitute 55.4 per cent of its business - higher than its peers - increasing its dependence on top clients.

A bigger problem is the possible take-over of PeopleSoft by rival ERP firm Oracle. Customising and maintaining PeopleSoft applications have been one of Hexaware's key revenue drivers, accounting for nearly 39 per cent of total revenues last quarter. Beyond doubt, any compromise on the PeopleSoft platform would hurt the company.

Analysts fear that Oracle's hostile bid for PeopleSoft would lead to the bigger fish cannibalising PeopleSoft products with its own. "There would be room for only two ERP in the market- SAP and Oracle," says an analyst.

Recent reports that the European Union has given the go ahead for the deal sours matters for Hexaware. However. if PeopleSoft maintains its identity under Oracle the element of risk for Hexaware will diminish.

While analysts remain fairly convinced about the Hexaware growth story, the sharp rise in its stock price in the past four months is making them wonder if it is time for a breather.

Some analysts say valuations are looking a tad heated at current dizzy levels and advocate buying at lower levels. They say though revenue growth would be affected in case of adverse developments in PeopleSoft, the company's growing avenues from SAP, business intelligence and document and content management services augur well for it in the long term.