HCL Tech and IBM (Part 2) More details about the deal: financials

/ December 9, 2018/ HCL Tech, IBM, M&A (large, with revenues above $50m), Unknown

HCL Tech provided additional light on its recently-announced acquisition of seven IBM software product for $1.8bn.

What is the scope of the deal?

HCL Tech is buying seven products, of which two are new (Commerce and Connections), and five were part of the previously-announced IP partnership (AppScan and BigFix in security; Notes and Domino, and Portal in collaboration; DX and Unica in e-commerce).

What is the financial profile of the acquired assets?

The additional revenue coming from this agreements is approximately USD 650m. This number includes new revenues coming from Commerce and Connections and incremental revenues for the existing five IBM products that were part of the IP partnership. These incremental revenues include IBM revenues that come on top of HCL Tech’s own sales from these products.

This raises the question: how large is the current IP partnership IBM business for HCL Tech? We are guessing this is currently a USD 400m-450m business for which the company had committed a $1bn payment to IBM. It, therefore, reaches pro-forma revenues of USD 1.1bn. This is sizeable.

The EBITDA margin of the acquired assets is approximately 50%. HCL Tech was keen on highlighting the financial attractiveness of the assets. This point raises several points.

  1. This EBITDA margin is twice as high as the rest of HCL Tech, whose margin has ranged between 20.7% and 23.5% since Q1 FY16
  2. HCL Tech alluded to the fact that IBM had under-invested in the seven software products. And the company has pointed it will reinvest in the products and launch new releases. This will investment will come at a cost, we think.

Is the deal that financially attractive?

This is the difficult question: the acquired business roughly has an EBITDA of USD 325m. The question, therefore, is what the impact of depreciation and amortization will be. We are guessing, based on historical data, the impact could be ~USD 100m. This is a guesstimate. So the acquired assets would an EBIT of USD 225m, representing a margin of ~35%.

The other side of the story is related to the organic growth of the acquired assets. HCL Tech has acknowledged the new assets have declining revenues. The company, however, highlights thanks to its investment in new functionality and to releasing updates, it has been able to bring back several of the software products back to double-digit organic growth.

In other words, evaluating the assets acquired by HCL Tech is impossible.

It seems however that HCL Tech will have a net debt of USD 300m, once the transaction is completed. This debt level is minimal, and HCL Tech can handle it very easily.


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