Even as the tech slowdown threatens to choke industry spend, Hughes Software Systems is talking of triple-digit growth.

By Ranju Sarkar

Last month, when Arun Kumar returned from the third GSM Congress in Cannes, France, he was all smiles. The tech slowdown in the US, the 45-year-old CEO of Hughes Software Systems discovered, would not clip his company's frenetic growth. Reason? The customers and telecom experts Kumar met in Cannes reassured him that R&D spend in telecom would not be cut back. That meant his eight-year-old company, which raked in Rs 144.9 crore by selling software and products to telcos, would end fiscal 2001 with yet another spectacular report card.

It still might. Except that, suddenly, the year ahead does not look so rosy anymore. Worse, if doomsayers were to prove right, Hughes could be hit harder than other software majors like Infosys, Tata Consultancy Services, Wipro and Satyam Computers, because of its sharp focus on the telecom sector. Says Sampath Reddy, Analyst, HSBC India: ''If there's a slowdown, Hughes will be hard hit. But as of now there's no evidence of any slowdown.''

Telecom In A Tizzy

A happy year ending-profits are set to surge by 47 per cent and the topline by 37 per cent-is no reflection of the future. Valuations of telcos such as Cisco, Lucent, and Nortel have been slashed by Wall Street, which fears lower earnings in the next few quarters. The carriers shelled out big money for 3g licences and the roll out of digital networks (US still largely has CDMA-based analog networks). In turn, equipment vendors who gave these service providers long-term credit are beginning to feel the squeeze.

Some analysts expect telecom spending in the US to grow by 8 per cent this year versus the 30 per cent in calendar 2000. Others feel even that may be an overestimation. Kumar, however, believes that the slowdown is overstated. ''Equipment vendors are trying to figure out when 3g services will be rolled out. The General Packet Radio Service (GPRs) has a shelf-life of one-and-a-half-years. Can people afford not to spend?'' May be not, but the $50 billion 3g roll out spend will probably get whittled down to about $20 billion, shrinking the size of the pie that will come Hughes' way. Says Alroy Lobo, Head of Research at Kotak Securities: ''The results of quarter ending June should have signs of a slowdown. So, that's the quarter on which all eyes are set.''

At least one part of Hughes' business should prove recession-proof: the one that comes from its parent, Hughes Network Systems (HNS), which makes up for 37 per cent of its revenue. Most of the billings from HNS, Kumar says, comes from new systems being developed for a next-gen satellite, due for launch in 2003. Funding from investors is believed to be in place, and therefore the odds of HNS turning the screws on the project are long.

In non-HNS services and products-which account for 35 per cent and 29 per cent of the topline, respectively-Kumar feels the numbers can only go up. ''We are helping build products for original equipment manufacturers (OEMs). They want to be ready (with new kinds of products) when the rollout begins,'' says he. Apparently, there is a 30-month window between development and deployment (18 months of development and 12 months of trials) that telcos now have to gear up for. Ergo, revenue from non-HNS services and products are expected to grow at triple digit rates.

Spreading Risks

While continuing to maintain its number one position in communications software industry, HSS has tried to spread its risks. Over the last five years, the share of HNS in revenue has come down from 84 per cent to 37 per cent. HSS has also diversified its product portfolio and widened to customer base. For instance, its revenue from non-HNS services has grown from 11 per cent to 35 per cent, while sales of products (components and sub-systems in VOIP and intelligent networks) increased from 5 per cent to 29 per cent between 1996-97 and 2000-01.

That apart, Kumar is looking at geographic expansion. Last month HSS set up an Asia-Pacific beachhead in Japan, and the year before it opened offices in the UK, Germany, and Holland. One of the reasons for a Europe push is that in some verticals like mobile data, the region is a bigger market than the US. Yet, there are a few hurdles it needs to negotiate.

For one, 68 per cent of HNS' revenue comes from its top five clients. In a good market this lends predictability to its revenue streams; in a sluggish market the dependency could prove tricky should the top five decide to lower tech spending. Part of the problem is also that some of Hughes' customers are tier-2. Explains a Mumbai-based analyst: ''You don't want to have tier-2 customers because they are the first to go belly up in a slowdown.'' Hughes knows that too, which is why it has been moving away from tier-2 to tier-1 customers.

The other challenge that Kumar must meet head on is of ramping up Hughes' products business. For starters, HSS must graduate from making relatively low-margin components to developing profitable sub-systems. Currently, Hughes uses a dual-business model in the products segment. For start-ups and small businesses, the preferred option is licensing, which allows revenue to be generated upfront. But in the case of components that it sells to smaller companies (sub-systems sold to OEMs), it follows a royalty-linked, risk-reward model. The rationale? Explains Manoranjan Mohapatra, COO, HSS: ''It's a question of market dynamics, although for recurring revenue opportunities, the biggies are better.''

Kumar expects the non-HNS services and products business to continue to grow at three-digit rates-they grew by 146 per cent and 263 per cent, respectively. But growth in products will depend on the company's ability to strike marketing alliances with OEMs. No doubt it has pre- and post-sell agents in the US and business partners in Asia and South Africa, but some analysts feel that the network is not big enough. Over the last two years, the company has roped in customers like NEC and Nokia (for services) and Italtel for products. Italtel, for instance, is expanding its network of 400 circuit-switched, soft-switch installations world wide to 600 over the next three years. Besides, it wants to transit from circuit-based switches to packet-based switches. Given that the royalty could range between $100,000 and $300,000 per installation, Hughes is looking at big numbers. But it will be 15 to 18 months before royalties start flowing in.

Consensus estimates put Hughes' operating margins at 36 per cent, down from the previous year's 40 per cent, due to high R&D and marketing expenses on Rightserve, an asp product, which it now is thinking of spinning off as a separate company. Still, analysts are bullish on the scrip. Kotak Securities, for instance, has it as one of its top three buys. Part of the reason is that the scrip, at Rs 601 is way off its dizzying January, 2000, high of Rs 4,848.25 (you guessed it; the scrip was one of Ketan Parekh's favourites) before a stock split. Even at its current price, the stock reflects a multiple 30 times its projected earnings in fiscal 2001. Says Kumar: ''The market sentiment had gone haywire. The levels weren't sustainable; but the Rs 1,400 level did seem sustainable.'' But even the most ardent of Hughes' admirers isn't in a hurry to crow the scrip back to those levels.

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