>HCL Technologies (MERRILL LYNCH)

HCL Technologies - Underperform

A long haul, yet,Underperform

# Earnings decline in FY10; Underperform
We reset our dated estimates & Price Objective established prior to Sep 08 and the Axon acquisition. While an 8% dividend yield could limit downside, we rate the stock Underperform given forecast earnings decline next year, on near term cyclical pressures, restructuring in BPO and steep margin dilution led by Axon. We forecast flattish FY11 EPS, on expiry of tax holiday. Longer term, we are positive on the strategic steps to position itself in growth markets and tighten operations. Our PO of Rs100 is at 7x FY10E EPS, at 20% discount to TCS, on relative brand and risks.

# Near term earnings challenges
We forecast a modest decline in organic revs in FY09 & FY10 (Jun yr end) due to cyclical pressures, with an estimated 40-50% of revs, across enterprise solutions, R&D services & application development, being exposed to cuts in discretionary IT spending. BPO, another 10% of revs, is also in restructuring mode from voicework to transaction processing. We forecast over 500bps margin decline over FY08-10 (prior to intangibles writeoff & stock comp) due to dilution from Axon and BPO acquisitions, hedging losses, weak European currencies & pricing cuts.

# Longer term, promising strategic moves
Longer term, we believe Axon significantly boosts HCLT’s position in SAP consulting, Europe, and new verticals like utilities. Also the US$1bn deal wins last quarter endorse a strengthening position in ‘run the business’ IT deals, though these will likely take 6 to 9 months to ramp, in our view. HCLT has also steadily improved bill-rates, utilization and lowered attrition over the last 3 years. Key upside risks: Faster than expected ramp of deals won and tax holiday extension,
which could boost FY11 earnings by 15 to 20%.

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