by on December 7, 2018

HCL Technologies (HCL) on Thursday announced that it will acquire select IBM software products for $1.8 billion. The transaction is expected to close by mid-2019, subject to completion of applicable regulatory reviews.


The announcement raised initial shock waves from analysts and industry watchers which in turn reflected in the stock. The questions are very evident- why such a huge payout for seven software products? Does the product business really have revenue scalability potential? Is HCL Tech paying too much and getting too little in the process? Will this impact dividends?


While there are lot of risks, as is the case in any acquisition, the management seems to have a long term strategy in play.


First the deal value


The company will be paying IBM $1.775 billion for seven products, which are across marketing, security and commerce. 48-50 percent of the amount will be paid when the deal is closed, between April and June 2019, while the remaining a year later.


It will pay a majority of the amount in cash via its internal accruals and about $300 million of debt will be taken to fund the deal.


As of September 30, 2018, HCL Tech had $1.59 billion net cash in its books. The payout of cash via internal accruals has been done keeping in mind its dividend distribution strategy as well as its commitment to scale business and invest in digital technologies. This means that HCL Tech will not take the entire cash on books, but a significant portion of it but at the same time it expects a good quarterly cash generation.


The company also reiterated that five of the seven products were already a part of an IP deal with IBM, where HCL Tech received a revenue share. While these five products have been acquired, HCL continues to work on an IP model with IBM for other products. So the $650 million is the incremental amount that will come in as a result of the acquisition.


The long term play


Once the deal is completed, HCL Tech expects an annual incremental revenue of $650 million from the acquired business. HCL Tech divides its businesses into Mode 1 (Core services), Mode 2 (next generation services) and Mode 3 (Products & platforms). The acquisition falls under the Mode 3 segment. Mode 3 recently hit a revenue run rate of $1 billion. Once the deal is done, the management expects to cross $1.66 billion of revenue run from the Mode 3 business alone.



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