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Krishnan Thiagarajan

Mr Arun Kumar, President and Managing Director... Banking on a revival in telecom spending

AT CURRENT price levels, the Hughes Software Systems (Hughes) stock looks attractive for investors with at least a one-year investment horizon.

Since the business environment for the telecom vertical continues to remain challenging, a large proportion of the revenue and earnings growth of Hughes may be back-ended (mainly in the third and fourth quarter of 2003-04).

As the earnings are likely to remain volatile, the Hughes stock may be appropriate only for investors with a high-risk appetite.

Management guidance: The top management of Hughes has indicated that its revenues will grow 35-40 per cent and profit after tax 40-45 per cent in 2003-04.

Though this may seem significantly higher than the industry average, it has to be seen in the light of two factors — the financial performance for 2002-03 and a comparison of that performance vis-à-vis projections made for the year.

First, for 2002-03, the revenues of Hughes (excluding `other income') at Rs 220.40 crore dipped by 6.2 per cent compared to the previous year.

The post-tax earnings at Rs 37.9 crore declined even more sharply by 21 per cent.

And for the full year, the operating profit margins also fell by more than 8 percentage points to 20.3 per cent.

Second, for 2002-03, Hughes had announced a guidance of revenue growth of approximately 15 per cent and profit-after-tax margin (or net profit margin) of 25 per cent of total income.

As is evident from the 2002-03 performance, its projections have gone haywire on both fronts.

The net profit margin in 2002-03 was 16.5 per cent of total income, mainly due to amortisation of the capitalised software development costs for product development.

The deferment of product development cost amounted to 5.7 per cent of total income for the year.

In the backdrop of these two factors, is the management guidance of Hughes on revenues and post-tax earnings growth realistic and achievable?

On the revenue front, Hughes recorded a third straight quarter of sequential revenue growth.

This robust performance, in a tough telecom environment, is encouraging. And in end-February, Hughes bagged a $30-million order from Lucent Technologies to be executed over three years.

As a part of this outsourcing deal, Hughes has added nearly 186 staff of Lucent to its employee count and proposes to set up a software development centre in Nuremberg, Germany, and expand its Bangalore facility.

This order may bring the much-needed stability and predictability to its revenue stream in the near term.

This order may also be a good referral for expanding its portfolio of non-HNS (Hughes Network Services) clients such as NEC, Nokia and Johnson Controls.

The strong contribution of non-HNS clients, at 47 per cent (up from 35 per cent in 2001-02) of revenues, is likely to remain the driver of Hughes revenues in the coming year.

In the fourth quarter of 2002-03, Hughes witnessed higher volumes from existing non-HNS clients and some revival of old relationships.

On the post-tax earnings front, a growth of 40-45 per cent translates into a net profit margin of 17-18 per cent of sales (excluding `other income').

Since the post-tax earnings for 2002-03 have dropped to Rs 37.9 crore compared to Rs 52.2 crore in 2001-02, the projected growth rates appear achievable.

The estimated operating profit margin (OPM) at 20-22 per cent used for working out the net profit projections seem realistic as they are in line with the OPMs recorded in 2002-03.

Considering these factors and predicating some recovery of capital spending in telecom in late 2003 and early 2004, the management guidance announced by Hughes appears achievable.

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