CASE : HOW DID HCL TURN AROUND WELL??

Axon is in line with the HCL’s M&A strategy, rationale for this deal. The company has identified 8 (eight) focus areas and this has been done with the help of a big consulting firm Enterprise application services was one of the such areas which was identified. So Axon was identified as a potential transformational opportunity way back in January to March 2008 period and they engaged in discussions with them since July 08. If you look at the cultural fit of this company, Axon is a performance oriented, highly employee centric culture, which matches with HCL’s philosophy of employee first. In terms of financial, it has a very strong and consistent financial performance. Their revenues they have grown in the last five years at 35% CAGR. They have an operating margin of above 18%, which is similar to the operating margin of HCL. This margin is commendable in spite of fact it is a consulting company with onshore operations. In terms of services it is complementing HCL’s application management and infrastructure management capability. Whereas Axon’s focus is on SAP, Business consulting, and implementation services, which is like 88% of their revenue whereas 12% of their revenues come from application management. When you look at the customers, most of the customers they have are not our customers. So they are strong in the UK Public Sectors and then they have clients
in the other defensive sectors like utilities, oil & gas, chemicals, etc. and so forth.

In terms of delivery, there is a limited overlap with the potential to grow the combined
business.

A transaction here is the offer to acquire the entire issued and to be issued share capital of Axon. They have offered 650 pence in cash for each Axon share, which includes an interim dividend of 2.25 pence. It values the company at 441 million pounds. These considerations they will be paying using a combination of our cash in hand, HCL has about $ 570 million in hand. It generates close to $100 million every quarter. They are going to use $41 million of their existing resources and they will be using loan of 400 million pounds to fund this acquisition. They anticipate that this transaction will close in the first calendar quarter of 2009 and the combined company; combined HCL and Axon will have a profit if this transaction goes through who will be their revenues of $2.3 billion. They will have these had revenues occupied 3 billion for FY 07-08 and this is on July to June basis.

HCL in the beginning focused on organic growth. They focused on cleaning up of our systems and processes so that they could bring about scale and focused on our employee policy so that they could integrate multiple cultures, multiple countries and get ready for the inorganic. Twelve months ago, they had announced the facts our intention of going inorganic and there are two business lines of HCL which could do with some change because one was the enterprise application services, another was BPO services. They looked at multiple companies across the world and Axon is amongst the few large-scale pure play SAP Company and that is what attracted us to Axon.

The first reason is that it is part of the 8 selected focus areas which they believe will drive HCL to higher growth part.

The second is that Axon services have a large blueprinting consulting services and implementation services and only 12% of their revenue comes from operations. At HCL service pack, more than 50% of our services come from operation services. When these two services are together possibility is a significant amount of operation services being rendered to Axon customer. So theoretical maths is going to be the fact that Axon could be a company which would be above 60% current service line and their operation services of 12% could potentially go to about 30-40% and that is an upside which is available with Axon customers. And that is because of the strength of application and infrastructure management of HCL.

One of the reasons they have not done well was the fact that our consulting
and blue printing services was not world class. They have already demonstrated cross sale and up sale as a big strength of HCL and generate significant revenue out of their large customers and they have some significantly large customers and therefore there
is an upside of revenues which will originate from HCL customers given the capability and services which Axon brings to the table. So complementary services is the second reason which is very important for HCL.

The third reason is that the enterprise application is a fast growth area across the board. However, enterprise application only constitutes 11% of its revenue for HCL whereas it constitutes about 24%-44% for other colleagues of ours in the industry. Therefore, it was important for us to scale up our enterprise application services so
that it can become optimum scale and they could become quite significant in this market. With these mergers of two practices which is Axon Practice and HCL Practice, they would be an enterprise application services would be closer to 30% of a revenue stream which is a right size model for us to move forward which is where you see the engineering services and the ADM services.

The fourth reason is that it is very interesting that the complementary verticals between our two organizations are an interesting overlap. They are largely in defensive sectors because our ERP is not very aggressive financial services their exposure to financial services is minimal and the defensive structures especially public sector government utility is of significant attractiveness to HCL because they are not present in large volumes. They have a few customers and not very large and there are a lot of mergers and acquisition play going on in that segment and showing up significant opportunities of selling SAP services and this will open new vertical opportunities for HCL, so it is not only just about horizontal enterprise application services but also our ability to open new verticals.

The fifth reason this is important for us is that they have the global service partner relationship with SAP. Therefore, they were 16th vendor to become one and the third in India and therefore our relationship with SAP management is quite strong and it is a global relationship.

The sixth point is that the SAP implementation across the world is driven by return on investment and the return on investment is decision is based on the business savings and they believe that the SAP spending although it is discretionary would remain predominantly because the custom application discretionary spending will migrate that amount of business towards more SAP implementation services.
It is interestingly noting that the SAP is dominating in Europe because their major market and the high growth market is Asia. Asia is HCL’s strong SAP market and Axon has Europe as its strong market.

The 7th reason is, a very large percentage of Axon revenue comes from few customers their top 10 account for a very large revenue and the reason at HCL they like it is because if such large revenues could come from a single customer, they understand how to make single customer’s multiple services. They did that with CISCO which was an engineering services company only. They did that Deutsches Bank which was ADM only; they did that with British Telecom which was BPO only so all their single services customers now on multi service customers and because of this strategic relationship and the in-depth SAP implementation work that Axon is doing with it customers and a very strong operation services articulation by HCL which is run the business, they believe they see a significant revenue opportunity from Axon customers. Now these are the 7 reasons why this is a strategic fit for HCL and that justified the premium which they would like to pay to try and merge this with our practice. However, acquisition is easy to do, difficult to make it successful, therefore 7 reasons which they weren’t through extensively debating within HCL and looking at the risk of integration and coming up with 7 reasons:

The first is that the extensive interaction with the management team and this is an exceptionally good management team and exceptionally bright and very proud people. They are extremely proud of what they have done. It is seen a high performance team and entrepreneurial cultural team a significant amount of pride in their brand and what they have achieved and an employee centricity in their culture and they see an identical HCL culture in Axon and therefore they believe that ability to integrate these two cultures would be easy because they are identical to the way they think and conduct our business, they do not suffocate people but they give them the air to be able, what they want and they drive our business manager based on the price and vision they have of the future.

The second reason they believe to succeed is this is not a first acquisition. They have 5 successful acquisitions which they have already implemented over the last few years and all of them have been successful not only in our ability to integrate the management team, who did not leave us or the senior managers who did not leave us but also converting these acquisitions into significant growth drivers. So when they take Alliance or Computech or Mass or Deutsche Bank or British Telecom all of them have been successful. What is interesting to know two of the largest which is Deutsche Bank and British Telecom are European acquisitions so they do understand European culture and they do understand how to integrate European companies within the HCL fold and the rest are American cultures, which also they understand and Axon is a big board.

The third reason HCL strategy and this is important to understand as to why would HCL small EAS practice be able to absorb a large SAP practice of Axon, HCL has always treated acquisition as a way of filling the gaps it had rather than a way of increasing the finer scale of what it already has. Historically, they have not acquired for scale or size. They have acquired for gaps and using those management teams, domain consultants or leadership they have been able to drive growth using their leadership. So BFSI actually did not exist as a strong vertical for HCL before they joined hands with Deutsche Bank in that venture so the BFSI vertical actually got created thanks to the Deutsche Bank acquisition. The telecom vertical in HCL got created thanks to British Telecom acquisition. They did not have a telecom vertical of any significance before BT came in. Same is true they were not even present in the government vertical outside India before they acquired Mass and that resulted into our getting into a government business. Those were verticals, so BFSI, telecom, and government have three successful verticals they created thanks to acquisition. Similarly, high end services Alliance was acquired in about 2004 and that resulted into HCL getting into SOA services. SOA services, they didn’t even one person on SOA services and the new articulation of enterprise transformation services you saw when similarly, when they acquired Computech that is the start of our oracle practice. So whether you take the oracle practice, SOAs or the vertical practice, these are examples of how HCL has used acquisition to scale up. So all of you who are worried about the facts that can a subscale service acquire Axon, five examples that you have to use that they have successfully done it, therefore it gives us a confidence that they would be able to do it again.
The fourth reason why I believe they would be successful is because over the last three years or all over the multiple years, they have done large transformational deals. In these transformation deals what happens is you have to have very robust employee processes, integration processes, knowledge transfer processes, (day 1 in-the-box, move-over-to HCL itself cultural kind of processes.

The 1st proof point that these processes have been evaluated by all global major sourcing consultants and customers it has won significant certificate of credibility from them.

The second proof point is that they have you know absorbed over 2000 employees worldwide these transformation transactions and have executed not only won these transactions but have executed them will which implies that our ability to absorb these people, integrate them with an HCL, at the same time give them the breathing space which they need to succeed has been exceptionally good.

The third reason that gives confidence of our ability to integrate, absorb, and execute our vision because acquisition is not a goal, what they do in acquisition is really what they are driving towards.

The fourth reason why they are confident is they have 6000 people in US and UK out of which they are equally split within US and UK and our ability to integrate 1300 new family members within HCL is not going to be difficult because they have the ability to do it, they have the structure to do it, they have the HR people to do it. They have done actually more complexities like the computer associate deal which they did was in excess of about 12-14 countries across the world where they integrated all the people into HCL on day 1 and then executed it on a worldwide basis.

The fifth reason that their ability of integrating people with high-end skills and absorbing them and not keeping them in isolation but using them to drive new revenues of HCL has been good. So when they acquired Deutsche Bank, they came in with significant high domain skills, those consultants who were based out of Frankfort, London, New York, and Singapore got financial services domain consultants and to be able to bring them in and use them to drive and create a new financial services, revenue stream for HCL was a challenge, which they think they did very well. Similarly Alliance was a consulting company on high-end consulting on SOA with bill rates in excess of $300 an hour. Their ability to absorb them, bring them in, not only to integrate them and not lose any of them our attrition rates in actually Alliance is less than 4% but use them to drive transformation for the rest of the services so when you saw the articulation of enterprise services transformation, it is the SOA layer which is driving change in the rest of the HCL business. So not only they have absorbed them well but they have also made them part of our growth engine.

And the last point their vision. The integration of the two teams is because the common vision of being the top 5 SAP vendor services provider in the world is a compelling vision for both of us to collaborate and make that vision happen.
That is the reason of DB, BT Alliance, Computech, and HCL Mass and they have successfully proven that business model so therefore when you look at this please look at its impact on HCL those on the revaluation of the stocks and also on underlying business performance.

The real battle will start in 2010 onwards and they have demonstrated to you that they have grown organically better with having very little in hand, with 2008 they have a lot in hand and with these acquisitions which they are driving our aim is to look at 2010 and beyond and that is the way you should see these strategic acquisitions and therefore whether it is accretive or dilutive. It is accretive but whether it is accretive or dilutive are less important compared to
the strategic fit it brings into place.