Digital GlobalSoft: Global Merger, Local Impact?

While the controversy over the HP and Compaq merger has died down, the future

of Digital GlobalSoft is yet to be fully clarified. The acquisition of Compaq by

Hewlett Packard resulted in a change of control at Digital GlobalSoft. The

acquisition means bigger opportunity for Digital to share its parent’s

outsourcing requirement. Moreover, the expected full or part merger with HP

India Software Operations (HPISO), a subsidiary of HP would increase the size of

Digital making it one of the major software services company in the country.

Digital GlobalSoft was formed as Digital Equipments (India) Ltd; a 51%

subsidiary of US-based Digital Equipment Corporation (DEC) in 1998. The company

was set-up to manufacture computer hardware, which included 64 bit Alpha chips,

VAX range of machines. Digital also provided onsite software services with

adequate help from the parent company.

While Digital gradually started providing more of offshore services, its

parent company DEC was acquired by hardware giant Compaq Inc in 1999 following

stiff competition in the hardware market. With an eye to focus on the growing

services segment in India, Compaq decided to acquire Digital’s hardware

business for a consideration of Rs 83 crore and a non-competing fee of Rs 5

crore. Consequently, Digital became a pure services company and was

re-christened Digital GlobalSoft in 2002.

Compaq Inc too couldn’t withstand the pressure and got merged with another

hardware giant Hewlett Packard (HP) in 2002.

Digital GlobalSoft currently provides bulk of the service to its post-merged

parent HP. Currently 51% of the company’s equity is held by the parent company

HP with FII’s holding 15%, mutual funds and financial institutions holding

14%, corporate bodies 3% and the balance 16% being held by the public.

HP is a US based hardware company engaged in providing product, technology

and services to users and clients. Its products include enterprise storage,

servers, PCs, desktops, workstations and printeRs HP services segment includes

business solutions, technology services, outsourcing, IT infrastructure, managed

services and enterprise applications. HP closed the year ended October 2002 with

consolidated (including Compaq) revenues of $ 72.35 billion with revenues from

HP services at $ 12.41 billion or 17% of the total revenues.

HP’s Indian software services subsidiary in India, HPISO is largely engaged

in providing software and R&D services with a staff strength of 1,000

people. Going ahead it is yet not clear if HP plans to fully merge HPSIO with

Digital or merge a part of the services of HPISO in order to have better

operational efficiency and project management. Initially, there were fears of

either HP de-listing from the stock exchange or acquiring the business of

Digital, which had led to a slump in Digital’s share price. However, it is now

clear that Digital would continue to remain listed whereas the merger

announcement is expected anytime.

Digital reported excellent performance in the full year ended March 2003 with

revenues rising 80% to Rs 332.11 crore and net profit by 71% to Rs 92.67 crore.

After the acquisition of Digital’s parent Compaq by HP, Digital witnessed a

slow down in its growth in the second quarter of fiscal 2003. Digital’s

revenues grew declined 1% to Rs 94.87 crore but the net profit was down 23% to

Rs 21.37 crore.

Digital however bounced back in the third quarter with excellent topline

performance. Digital’s revenues jumped 26% y-o-y and 16% q-o-q to Rs 109.98

crore whereas its net profit advanced 10% y-o-y and 26% q-o-q at Rs 27.01 crore.

Digital’s operating margins improved from 24.31% to 28.03%. Digital provides

software services in the area of enterprise applications, system engineering,

enterprise solutions, e-Infrastructure and telecom. The company currently

achieves major revenues from the enterprise application and enterprise solutions

segment. Digital has a separate telecom business unit and is also developing

capabilities in the finance and insurance verticals.

The application services, which consist of development, integration,

migration and post development of various applications, are provided to both its

parent and other clients. In the third quarter ended December 2002,

E-Application revenues grew 24% over previous year and formed 48% of the total

revenues. Enterprise Solutions, which consists of ERP, e-CRM, e-Procurement and

SCM practices, was formed in 2002. Enterprise Solutions provided 31% of the

total revenues in the third quarter and grew by 49% over the previous year.

Digital entered the BPO space during the year with the launch of Digital

Contact Center, which clocked revenues of Rs 1.20 crore during the 9 months

ended December 2002. DCC is currently providing services to its parent and

provides email-based support to hardware users. DCC is still in the initial

stage of operations and has reported loss of Rs 4.50 crore till December 2002.

DCC has witnessed a slow takeoff as it was launched during the acquisition of

Compaq and is likely to breakeven only in the next two quarters This is likely

to further improve Digital’s performance in 2004.

Digital’s has seen an improvement in non-parent revenues since the past few

quarters. Non- parent revenues have increased from 13% of total turnover in the

third quarter of fiscal 2002 to 22% in the third quarter of fiscal 2003. In

absolute terms, Digital witnessed a 3% sequential decline in the revenues from

its parent in the second quarter due to a delay in some of the projects on

account of integration of HP and Compaq. However, these have jumped 14%

sequentially in the third quarter, which was largely responsible for the

improved performance. Digital added 252 employees during the third quarter

taking its total staff strength to 2003. Offshore contributed to 37% of the

revenues in the third quarter of fiscal 2003 compared to 31% in the

corresponding quarter last year.

After a brief break in its otherwise rapidly improving performance, Digital

has once again back on track and is expected to post strong fourth quarter

performance. Market report indicate that a large number of MNC’s that include

IBM, Oracle, Accenture, and EDS plan massive expansion of their offshore

operations in the next 2 years. HP too has a strong commitment towards its

Indian companies and we feel that outsourcing services from India would be a

compulsion if these companies have to remain competitive. Digital is likely to

benefit from increased outsourcing by its parent company in the near to long

term.

Digital currently trades at Rs 588 discounting our estimated march 2003 EPS

by 18 times and march 2004 EPS by 14 times.

The stock had dipped recently on announcement of the disappointing second

quarter results, which were largely due to the slowdown in some projects from

Compaq due to its merger process with HP. However the third quarter results have

been outstanding and with the company now focusing on a much larger share of HP

requirement, the fourth quarter results are expected to be strong. Moreover, the

announcement of the merger between digital GlobalSoft and HP services, the 100%

software subsidiary of HP is also likely to be announced soon. We believe that

the merger is likely to further push Digital among the major software players.

In terms of performance, Digital’s expertise in application solutions and

strong technology understanding would enable it to outperform its peers in the

near term. Digital’s BPO initiative is also likely to have a major impact on

the performance going ahead. Digital’s stock is expected to remain firm and

move up after the announcement of the fourth quarter results or the merger.

Market Outperformer

Sushanto Mitra is the founder

of Technology Capital Partners