TECH: In-depth Bizz. Feature: Should HCL sell off its hardware business?

Should HCL sell off its hardware business?

The performance of HCL’s hardware arm has lagged behind for years, in sharp contrast to the IT player’s consistently stellar performance in the software business. Would it not be a smart strategy if the company were to shed its hardware heritage?

Late last month, HCL Infosystems Ltd, a subsidiary arm of the $6 billion global technology and IT enterprise firm Hindustan Computer Limited, or HCL, announced that it was planning to hive off its hardware business into a separate unit in order to bring a sharper focus to its computing business and to streamline operations and bring in better economies of scale. The move did not come as a surprise as HCL’s hardware business has been in a trough for the past four years and its remarkable underperformance has stood in sharp contrast to the company’s software business.

Over the years HCL has become an emblem of the Indian software prowess and has come to be identified with the big four of India’s information technology services firms. Founded in 1976, HCL has come a long way from its early days of doing contract work for leading technology giants like Hewlett Packard and IBM. Riding the crest of the software boom in the 1990s, the leading Indian computer manufacturer branched out into software manufacture in the mid-90s with HCL Technologies, and consolidated its IT and ITES services under this arm (even taking HCL Infosystems’ software work in its fold), while the original hardware core was turned into HCL Infosystems.

But while HCL Technologies has prospered and thrived beyond expectations, HCL Infosystems, which is into computer manufacture and other IT products, solutions and related services business, has consistently underperformed over the years. A look at the latest quarterly results brings out the stark difference in the comparative performance between the two entities. HCL Technologies has sprinted ahead to become India’s fourth-largest IT services firm behind TCS, Infosys and Wipro, and clocked the highest q-o-q growth at 13.5% in the just concluded April-June period, ahead of its larger rivals. It posted Rs.51.92 billion in Q1 revenue – a 42% jump compared to leader TCS’s 14.2% Q1 growth, Wipro’s 6.2% and Infosys negative -1.2% show. In contrast,

HCL Infosystems, whose financial year runs from July to June, reported revenue of Rs.114.19 billion in the year ended 30 June 2011, just marginally better than what it was five years ago, when it had reported revenue of Rs.113.68 billion for fiscal 2006. What’s more, its operating profit dropped 24% during the period. Its latest Q3, FY2012 results show a negative growth of 5% in revenue from Rs.27.58 billion in Q3, FY2011 to Rs.26.12 billion in Q3, FY2012. According to technology consultancy Gartner’s first quarter (January-March 2012) survey, HCL’s PC market share dropped to 5.8% in the first quarter of 2012 from 7.1% in Q1 of 2011, as it experienced a 13% year-on-year decline from the first quarter of 2011. Considering that the Indian economy grew at a healthy pace for most of this period, and aggregate profits of many a listed Indian companies have been growing in double digits each year, a decline in profit over a five-year period reflects a sad state of affairs for HCL Infosystems.


In 1998-99, HCL’s Chairman Shiv Nadar consolidated his 18 group companies into five companies - HCL Technologies, HCL Infosystems, NIIT, HCL Comnet and HCL Perot. Next year, the five companies were further streamlined into three - HCL Infosystems, HCL Technologies, and NIIT. HCL Comnet Systems and Services was merged with HCL Technologies, while HCL Perot Systems was assimilated through a 50:50 JV between HCL Tech and Perot Systems Corp. In keeping with the US laws, an important market for HCL Technologies, Shiv Nadar exited from the boards of NIIT and HCL Infosystems. He, along with Ajai Chowdhry of HCL Infosystems and Rajendra Pawar of NIIT, aimed to re-write the script in the Indian hardware and software space, with the three companies serving every need of the market. Way back in 2000, Nadar aimed to merge the hardware and software technologies (something which the likes of today’s global tech giants like Google, Apple, and Microsoft are going for).

But the HCL story has not played according to the script. While, HCL Technologies flourished as it competed in a global market, and acquired international talent, competitiveness and skill set, HCL Infosystems and NIIT seem to have a serious problem with its business and earnings model. They never acquired an international market, and once International players like SAP, Oracle, Microsoft certifications (for learning space) and the likes of HP, Acer, Lenovo in the hardware space, entered the Indian market, HCL was just not able to compete. In fact HCL Infosystems still outsources most of its manufacturing components from China for assembling, and its branded products like the ‘Me’ PCs and tablets are hardly considered a technological innovation and work mostly with price-conscious consumers. On the other hand, NIIT is trying to fight back by also getting into the software development space. But its HCL Infosystems, which seems to be dragging the group down in recent years.

Consider this: HCL Infosystems’ share price has been on a continuous downslide over the last five years. From almost Rs.100 around May in 2011 it’s down to just about Rs.37 at the end of July 2012. It looks even worse from a historical perspective, when the share price was zooming at Rs.296 in January 2008. On the other hand, HCL Tech stock price has risen like a hot air baloon. It was trading around Rs.98 during the peak of recession in January 2009, but darted its way up to around Rs.516 as of end of July 2012. Clearly the two stocks tell two different stories – one of success and one of rapid decline (we know which one we’re talking about).

According to Harsh Chitale, MD, HCL Infosystems, who took over the reins of the company about a year ago (in tough times), loss in foreign exchange due to a rapidly declining rupee (trading well over Rs.50 to US dollar) and a slowdown in new projects are the main reasons affecting the business performance of the company. The company has been adversely affected by the rupee’s depreciation against the dollar, as it imports a good part of the equipment that it assembles and sells. To aggravate the woes of the company, the desktop market, which used to be its bread and butter segment, has been very lacklustre of late in the face of the tablet invasion and laptops becoming more pocket-friendly. In the computer systems business, global players such as Dell, Acer, HP and Lenovo have made serious inroads in India and have increased their market share (10-15% each), while the share of HCL has been steadily coming down over the years. According to Chitale, “the laptop business is a challenge for us. In the last six quarters we have lost some share. We don’t have economies of scale like big players, who make 30-40 times of our capacity. They have multiple sourcing strategies, whereas we don’t have that leverage.”

In its technology distribution vertical, HCL’s key customer - Nokia - is not dominating the phone market the way it used to do a few years back. In August 2006, HCL Infosystems lost its status as the sole distributor of Nokia phones in the country. Nokia had then reworked its distribution strategy, becoming a joint distributor along with HCL Infosystems. One would have imagined that with the base adjusting in the first year of joint distribution, things would have stabilized for the company thereafter. But not only have things not stabilized with respect to the phone distribution business, what’s worse is that the outlook remains bleak. Nokia has been losing share rapidly to other manufacturers, and this will continue to impact HCL’s phone distribution business. For the last accounting year ended 30 June, 2011, revenue and profit of this division fell by 8.5% and 10.7%, respectively.

Experts feel it’s not a bad time for HCL to revisit and refocus on its three company strategy. The focus should be more on HCL Tech, which is the winning horse for the parent company. Katyayan Gupta, technology analyst, Forrester Research, says: “Definitely it makes for a better business sense to focus on HCL Technologies, as it’s doing very well currently.” After all, HCL Infosystems is not into any cutting edge technology game, hence its margins are low, due to the commodity nature of its business. “Putting more resources into the HCL Technologies and making it a pure play tech company will be a more sustainable and winning strategy in the long term,” says Gupta.

But for this to happen HCL will have to shake off its old mindset, and not see itself just as an Indian back-end technology provider. Today, the likes of Google and Microsoft are getting into the hardwa e side, and companies like Lenovo and EMC have joined hands to offer technology services like storage space in key markets like China. That’s because mobility has emerged as the biggest disruptive technology, and everyone is trying to accommodate it. Obviously, HCL can’t sell-off HCL Infosystems completely,

as it will heavily hit the parent company’s top line. But hiving off its PC business makes better sense. “It can then focus on mobility devices like smart-phones and tablets, though I still wonder why HCL hasn’t got into the smartphone space,” says Gupta. There is a big vacuum after Samsung, and people hardly buy that many LGs or Sony, so there is a chance of HCL tapping that market, as it can play on its strengths of producing better apps and localized content, besides also riding on its distribution strength. “If it can develop apps for others, why can’t it do the same for itself,” asks Gupta.

But whether HCL can get into the global league of Google and Microsoft is a tough call for now, as it requires a culture shift, and a sustained effort over a long period of time. But if any Indian company can do it, then HCL is one of them. But it will have to significantly upgrade its hardware skills, which is not impossible considering its experience and current strengths. Also, it needs to combine its hardware and software development skills to develop both products and services, which can be delivered on the basis of its present distribution might. It’s been a decade since HCL restructured itself, and a decade is no less than a century in the technology world. Considering the slack that HCL has to pick up on account of its laggard hardware business there couldn’t be a better opportunity for restructuring its overall business than now.

Insider view: 

B&E: HCL Infosystems is facing pressure on its profit margins. This is despite the fact that you exited the netbook market, which was pulling in good sales. How do you explain this?
Princy Bhatnagar (PB): We exited netbooks in June last year even though sales were very good. The netbook segment created a 400,000-unit demand in the Indian market, which is pretty big. What has happened is that consumers have very well segmented what is a computing product and what is a consumption product. With the advent of tablets, and increase of computing power on a notebook, this behaviour has become more visible. They sort of strike a balance. In the lower rung segment, if people are buying a third device - let’s say a consumption device - then it’s normally a tablet. Pure computing has evolved to far more powerful devices than where it was two years ago. So netbook demand is lesser. It’s like the digital frame device - it never came to India, unlike in the US or European market. It never really took off in the market. Our market never touched that phase of evolution.

B&E: Is the currency situation further eroding your profits?
PB: Who is making money anyway? I don’t think anyone was prepared for the currency situation. It’s not just about the IT industry, it’s happening across industries. As a marketplace, it’s not a very comfortable place to earn profits right now. You have to redouble your efforts many times over. We made a 5% hike in prices in May when the currency downward movement started, across our computing range products.

B&E: Where do you see HCL Infosystems in the Indian computing market over the next five years?
PB: (Smiles) Please don’t ask me that question since it’s a dynamic sector. B&E: What are you major product lines and brands?
PB: We have desktop PCs, laptops and all-in-one products in the consumer segment. In the mobility segment we have our tablet range. In the enterprise segment, we have servers and thin client offerings. The major brands we have are ‘Beanstalk’, our premium range computing brand, ‘Ezeebee’, our normal desktop brand, ‘Me’, which is the brand for our laptops, and our commercial range of desktops and servers under ‘Infiniti’.

B&E: Any sales target you have set in the smartbook range that you launched in the current quarter?
PB: We are not setting any numbers in terms of sales. This is more to understand where consumer trends are going and how adoption will happen. In the case of the smartbook range we just launched - a soft launch - we will know how this product is doing in the course of the next 2-3 months. So if your research findings indicate that there’s a space which has a particular speed, need or features, then we have come pretty close to meeting that segment’s need. So I can’t really say where we are headed in terms of sales, but segment creation is what we are trying to do.

B&E: How much has HCL benefited from the various government contracts like those from Tamil Nadu and UP, where computing devices were offered as poll promises?
PB: In Tamil Nadu, we have bagged a total order of 200,000 units. There have been some issues related to pricing and we are doing appropriate representation with the government. The problem has occurred due to the currency movement, from Rs.43 to a dollar when the bid was priced, to over Rs.52 today.


The story was done by me in 2011 for Business and Economy magazine