HCL's 'leaky bucket' points to big holes in renewals business​

Despite announcing large new deals, the company has been unable to boost its incremental top line.

Yesterday there was a Mint report on HCL Technologies, an erstwhile wunderkind in the IT landscape in India, suggesting that despite the company claiming more than $1 billion in new contracts every quarter since the July-September quarter of 2012, HCL's bottom line simply does not reflect these gains.

If this is the case -- no robust revenue growth despite new and bigger deal announcements -- then HCL has a real problem on its hands.

According to Mint, HCL has been struggling to win repeat business, or 'renewals', which is bread-and-butter to firms today. Mint said that the firm let at least $1.5 billion worth of business that came up for rebid over the past two years slip through its fingers thus giving it a ghastly 'net erosion rate' of 20 percent. (Check out the report to see the listing of deals the company has allegedly lost.)

The company has responded by asserting that "retention rate for deal renewals is at 98%" but not much else to explain or counter Mint's assertions in a more detailed fashion.

So, what's going on here? Mint's writer has done what any good journalist should -- look under the hood and do some basic math. What it has come up with are some pretty interesting numbers.

Its basic research points out that between 2008 and 2012 the company added revenue of $2.2 billion on the back of winning $8 billion worth of new deals. However, between 2012 and 2015 the company could only add $1.8 billion despite winning more than $11.5 billion in fresh business. In other words less revenue for significantly more business.

One reason for this, according to a research analyst? "The Leaky Bucket Theory".

"Of late, it has become fashionable to talk qualitatively of order books and TCV (Total Contract Value). While that will no doubt help in bringing more water to the bucket, what if the bucket itself is springing leaks that cause the already stored water to deplete?" asked JPMorgan Chase's analyst Viju George in an investor note in April this year as reported by Mint.

"Leakages in the existing book of business are a bigger concern as that is likely to negate gains from newer larger deal wins," George added.

There appear to be two main threats to HCL's revenue generation: First, new deals also include the cost of hardware and bandwidth that go along with the project on which the company makes almost no money but which can pad the face-value of the deal by 40 percent.

The second threat is, existentially speaking, deadlier: What HCL has excelled in for the last decade or more has been in the infrastructure services sector, a division that current CEO Anant Gupta helmed, and a major contributor to the company's success. And yet it is this division, and contracts and deals within it, that are under threat as customers worldwide have begun their shift to cloud computing thanks to Microsoft Azure and Amazon AWS. Cross-selling, according to Mint, has also become more difficult as companies today prefer to deal with fewer technology providers. According to the newspaper, over a dozen clients, including UBS Group AG and Microsoft Corp have decamped to the company's rivals.

A few years ago, HCL was India's stock market darling, returning "195 percent versus 78 percent for Indian blue-chip giant TCS, 12 percent for the embattled and out-of-favour Infosys and 29 percent for Wipro. However, if you expand the time period to 5 years, the results are even starker. A massive gulf opens up between HCL and the rest of the pack with an HCL share returning 12.24 times your investment versus 6.28 for TCS, a desultory 1.4 for Infosys and an underwhelming 2.64 for Wipro".

At the time the new CEO Anant Gupta was riding high on the gaudy returns stoked primarily by the infrastructure services division, a department that now ironically appears to be in some kind of existential crisis with the encroachment of cloud services.

Today, it may have to do some detailed explaining to unravel the mystery of its leaking bucket.

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