Geometric buy too small to make a big difference

While it offers access to key clients, slowing revenue growth, lower margins are key concerns

The rising buzz around acquisition has led to strong out-performance of the Geometric scrip in the past year. The stock has surged 11 per cent versus a flattish show by S&P BSE IT index. But, a large part of these gains have come in the past month, wherein the stock has jumped 28 per cent ahead of S&P BSE IT index's 5.7 per cent as the buzz of acquisition got stronger.

The scrip, however, fell 4.3 per cent to Rs 196 a share on Friday, partly due to news reports suggesting that the share-swap ratio in a potential buyout by HCL Technologies was unfavourable for Geometric and valuations were lower than stipulated earlier. Based on Friday's closing price, the deal size is pegged at $190 million. The share swap ratio of 10 shares of HCL Technologies for 43 shares of Geometric, however, appears to be skewed in favour of the former, as anticipated by the market. These, along with the sharp rally in the Geometric scrip, explain why the stock fell on Friday.

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So what does this buyout mean for HCL Technologies?

Despite its smaller size (FY15 revenues of Rs 1,105 crore), Geometric buyout will give HCL Technologies access to clients such as Siemens, Volvo, Ford, Goodyear, John Deere, Caterpillar, Chrysler, among others. The key negative though is that Geometric's 58 per cent stake in its joint venture (JV) with Dassault Systemes is not part of the deal. This JV forms one fourth of Geometric's revenues and some analysts were estimating that HCL Technologies could get deals from Dassault in exchange for the Geometric buyout.

The other flip side is that though Geometric has a good presence in engineering services (30 per cent of revenues), growth has been slowing recently. "Geometric has a weak business. PLM (product lifecycle management) implementation, outsourced product development, outsourced mechanical engineering work are all slow-growing areas and contribute 90 per cent of the business. Further, high onsite mix shows that processes are not mature," says Sagar Rastogi, IT analyst at Ambit Capital.

Overall, while this small deal will add to HCL Technologies' profits from day one, it will be margin-dilutive given that Geometric posted profit before interest, depreciation and tax (PBIDT) margin of 17.2 per cent and net profit margin of 9.7 per cent in first nine months of FY16.

HCL Technologies, on the other hand, posted PBIDT margin of 21.2 per cent in the first half of FY16 (year ending is June) and net profit margin of 17.8 per cent.

Net-net, the impact is unlikely to be meaningful for HCL Technologies given Geometric's relatively smaller size.