HUGHES SOFTWARE SYSTEMS: Having Slipped a Few Rungs…

Delhi-based Hughes Software Systems (HSS) is a subsidiary of HNS-India Inc,

USA. HNS-India is a wholly owned subsidiary of Hughes Electronics Corporation (HEC),

set up to pursue software development services in India. HNS provides satellite

and wireless communication ground equipment and services. HEC is a subsidiary of

General Motors Corporation, one of the largest auto manufacturers in the world.

HNS- Mauritius Holdings, a company formed by HNS-India and HNS-India—VSAT,

both affiliated to HE, owns a major part of the equity in the company.

HSS was primarily formed to execute software projects for the parent company.

HSS came out with a public issue and offer for sale by the promoters in May

1999. The offer was made through book building and fixed price issue at a price

of Rs 620 per share. The company raised a total of Rs 54.20 crore, which was

utilized for the expansion plans of the company. The company later reduced its

face value from Rs 10 to Rs 5 per share. Currently, HSS is 56 % held by the

promoters with foreign institutional investors holding 7%, mutual funds holding

4%, private corporate bodies and others holding 19% and the public holding the

balance 14%.

HSS is engaged in providing software solutions and product development in the

area of telecommunication. The company currently derives its revenues from three

sources namely software services provided to its parent HNS, software projects

and products, all in the telecommunication area.

HSS provides software services in the area of switching technologies, access

technologies, network management systems, intelligent networks, real time and

embedded system and computer telephony integrators These services are provided

to its parent company–HNS and other leading telecommunication companies, which

included OEMs and Telco’s.

Leveraging on its expertise in executing telecom related software projects,

HSS has developed a number of products over the past few years The company has

developed products for both OEMs and Telco Companies, in the area of Protocol

Stacks, Intelligent Network Solutions and VoIP. The company gets revenues on

sale of the products and the flow of revenues continues by means of royalty as

the network is put in place. The recent slowdown in the telecom spending has

impacted the company’s products business. HSS went through a difficult phase

in the year 2002 as the global telecom industry plummeted sharply. Most of the

telecom OEM’s ceased investment in new development as their sales plummeted

sharply. HSS too felt the pressure as it witnessed lower than expected growth in

revenues and pressure on operating margins due to higher R&D expenses. HSS’

profitability was impacted as its net profit declined 17% even as its revenues

went up by 18% in fiscal 2002. After a disappointing first quarter for the

current fiscal, HSS has improved its performance in the second and third

quarter.

HSS’ revenues declined 25% y-o-y and 18% q-o-q to Rs 47.40 crore. In the

second quarter ended September 2002, HSS’ revenues declined 3% but the net

profit was up by 32%. The performance in the third quarter ended December 2002

saw its revenues from HNS growing 5% q-o-q whereas the revenues from services to

clients other than HNS grew by just 7% q-o-q as against 12% q-o-q growth in the

first quarter and 17% q-o-q growth in the second quarter. Product revenues grew

4% q-o-q whereas revenues from the BPO operations generated Rs 40 lakhs during

the quarter. While the improvement in the margins is a positive sign, the drop

in sequential growth in the services revenues from non-HNS clients is a cause

for concern.

Notably, the revenues from the top 5 clients declined from 70% in the

previous quarter to 58% in the third quarter. The company has also changed its

accounting policy relating to the treatment of R&D expenses and it now

capitalizes a part of these every quarter. HSS has written of R&D expenses

amounting to Rs 3.70 crore in the first quarter, Rs 3.50 crore in the second

quarter and Rs 3.00 crore in the third quarter of the current fiscal. HSS

reduced the debtor outstanding days from 130 in the second quarter to 103 days

in the third quarter. HSS plans to convert outstanding of $ 3 mn into equity

stake in one of the clients group company.

HSS is focusing on domestic business as well as on key and major accounts to

ensure repeat business and sustainability of its operations. HSS achieved 80% of

the total revenues from the top 10 clients whereas the top 5 contributed to 58%

of the business during the third quarter. Moreover, the company achieved 95% of

its revenues from repeat business. Its major customers were the parent company

HNS, Nokia, NEC, and Johnson Contract and HSS has plans to focus on these major

customers. Having witnessed a sharp impact on the business due to the telecom

shakeout, HSS has decided to enter the BFSI space to provide software services.

With the BFSI segment witnessing continuous growth despite the overall slowdown,

HSS believes that the strategy to diversify would stand good in difficult times.

The company is in the process of putting the BFSI team in place.

On the other hand, HSS’ commenced its BPO operations during the quarter,

ahead of its schedule. HSS has completed a pilot for its parent HNS and achieved

revenues of Rs 40 lakh during the quarter. It subsequently plans to provide BPO

services in the financial area as well. HSS’ BPO operation currently has 75

people and the company has invested close to Rs 9.30 crore in its BPO

operations.

Going ahead, HSS has estimated a sequential growth of 10% in topline in the

fourth quarter, which would be unimpressive considering that the company would

see a jump in the revenues from BPO operations. With the revenues from products

being volatile, we feel that performance in the next quarter would largely

depend on the performance of its services segment. HSS’ operating margins

could decline in the next two-three quarters until its BPO operations stabilize.

HSS would also witness increase in expenditure relating to marketing relating to

its diversification in the BFSI space.

HSS currently trades at Rs 171 discounting our projected March 2003 earnings

by 17 times and March 2004 EPS by 13 times. The stock price had increased over

the past couple few months on expectation of impressive third quarter results.

HSS went up from a low of Rs 130 in early October 2002 to a high of Rs 218 in

December 2002. While the results are not disappointing in terms of growth, they

still reflect the weakness in the telecom sector.

The company’s performance would therefore depend on the success of its

strategy on focusing on key clients and expand business opportunities. In terms

of performance, we expect a weak fourth quarter, which would keep the share

price subdued. In fiscal 2004, HSS would see improved revenues from the BPO

space and likely improvement in the telecom space. HSS fell 15% after the

announcement of the third quarter results and the share price is unlikely to see

major upside form the current level. Market Performer

Sushanto Mitra is the founder

of Technology Capital Partners