The merger of Hexaware and Aptech’s software business was proposed a while ago, but it actually happened only a few months back. Rajneesh De & Srikanth R P check out how Hexaware has performed post-merger, and whether things have really worked out for Hexaware as envisaged by the promoters

Atul Nishar believes that Hexaware has grown out of Aptech’s shadow, and is well placed to grow into a software giant

Nasscom president Kiran Karnik often laments the fact that the top five Indian software firms contribute almost 80 percent of total revenues for India Software Inc., which leaves most of the rest of the pack as far smaller, or worse, insignificant players. While it is true that a few biggies such as Infosys, TCS, Wipro and Satyam dominate the Indian software services business, it is also a fact that there are smaller companies that have carved out their own niche and are often regarded as experts in their particular domain. The Rs 288–crore Hexaware is one such player, with strong expertise in PeopleSoft implementation and Enterprise Application Integration (EAI).

The company has been in news recently, mostly in somewhat controversial circumstances, following its merger with Aptech’s software arm. But now, with all the merger and stock swapping issues resolved, Hexaware chairman Atul Nishar believes that the merger has increased the scale of operations and has also expanded Hexaware’s range of offerings, has brought about greater access to customers through a larger sales team, and also more customer references. As a result, Hexaware today, he believes, has extremely strong offerings and has positioned itself well to bid for and win large offshore projects.

This unbridled optimism calls for a closer scrutiny of the benefits of the merger and an analysis of the future dynamics of Hexaware’s functioning.

Post-merger, the combined entity’s turnover was pegged at Rs 222 crore (as on December 31, 2001) and that will put it into the same league as any second-rung software player. The optimism stems from the fact that the company has a healthy order book of over Rs 450 crore in hand. The results of the merger are starting to show, with Hexaware’s revenues in Q1 2002 and Q2 2002 touching Rs 50.9 crore and Rs 65.2 crore, a 28 percent quarter-on-quarter sequential increase. Another positive fact, according to P K Sridharan, executive director with Hexaware, is that the company has around Rs 80 crore of cash in reserves, which can be used for inorganic growth through the acquisition route.

The new Hexaware is aiming for revenues of around Rs 260 crore for 2002, but one cannot simply add up all the projects and revenues of the two companies and put it under one entity in a one-plus-one-equals-two calculation. There is a feeling among several business analysts as well as investors that Hexaware bagged a lot of projects using Aptech’s brand name, which is a fair practice prevalent among group companies. But now Hexaware will have to slug it out on its own, without the facility to leverage the Aptech name.

Bones of contention
Even before Hexaware started functioning as a separate entity, its stock swap ratio generated some controversies. According to Nishar, the de-merger ratio (between the Aptech training and the software services business) was arrived at based on net

assets, while the swap ratio for the Hexaware merger took into account discounted cash flow (DCF) values, net asset values, listing (the fact that Aptech is listed while Hexaware is not) and earnings. However, considering the company’s market capitalisation of around Rs 330 crore in June 2001 (at the time of announcement), Aptech Software with 40 percent share was valued at about Rs 130 crore, while post-demerger it will have

177 crore in cash alone. On the other hand, Hexaware’s cash position was estimated to be only around Rs 9 crore. Besides, it had a debt burden of around Rs 19 crore on its books, while Aptech is debt-free.

Thus, in the prevailing difficult conditions, Aptech Software’s strong cash position would obviously be quite advantageous for the combined entity. Therefore, some analysts argue that the Aptech’s Software business appears to be undervalued when determining the swap ratio.

According to P K Sridharan, Hexaware’s cash reserve can be used for growth through the acquisition route

Hexaware strategies
Explaining the rationale for restructuring, Nishar says that the training and software businesses have different growth profiles. Their target markets, customer profiles and key success factors are different. He feels that the demerger of Aptech Software from Aptech Training and its subsequent merger with Hexaware would allow for easier acquisitions and better management focus in the two businesses. According to him, both the companies had similar organisational culture and so there was no problem in a fit. Incidentally, the new entity is now India’s 11th largest software company.

Nishar tries to put to rest any doubts about Hexaware’s ability to attract good projects even when the Aptech brand can no longer be used. He bases his case on Hexaware’s strategy to stay away from the services crowd and instead focus on the enterprise application integration domain. Sridharan adds, “As a mid-sized company, it is clear that we cannot currently compete with the big companies on the software services part. Hence, we have to acquire a clear differentiating skill set, which is a value add that customers cannot afford to ignore. By concentrating on the EAI and PeopleSoft domain, we have done just that. This gives us an opportunity to enter into large accounts without using Aptech as a crutch and it also acts as a clear differentiating strategy from the software giants. In addition, this gives us better margins than the traditional areas. Going forward, we would like to position ourselves as the number one player in the PeopleSoft domain.”

Nishar’s boast that Hexaware can acquire clients on its own seems to have been vindicated, considering that in the last quarter Hexaware gained incremental revenues from new clients. Hexaware acquired 10 major customers, many with the potential of billing over a million dollars each in the next 12-18 months. Two of the newly acquired customers are from the airlines industry, while four are from the PeopleSoft practice. As a result, offshore revenues grew from 31 percent in Q1 ‘02 to 36 percent in Q2, thereby increasing gross margins from 27.3 percent to 37 percent during the same period.

Besides higher margins, the focus on PeopleSoft has opened new doors for the company in other disparate areas and segments. Experts say Hexaware is following the ‘top to down’ approach instead of the ‘bottom to top’ approach that most software companies are following. Explains Nishar in more detail: “Once you win clients, the strategy is to offer more solutions to them and increase the depth at each client site. We expect to win more projects around mainframes and in the EAI space from our PeopleSoft clients.” In addition, the long association with PeopleSoft has helped Hexaware acquire the latest product knowledge and has helped it hone its skills in the product life cycle space.

This focus has seen the company winning significant orders like Exult in USA for its Offshore Application Centre; a contract worth $30 million spread over five years for PeopleSoft Applications (Bank of America and Gibraltar Insurance). Other orders include Valtech, France for its dedicated development centre, worth $25 million over 3 years in the EAI and e-commerce areas (Websphere and Weblogic); Airline Software Company Canada for $20 million over five years in the areas of EAI; Citibank Germany’s offshore development centre for $12 million over four years in the areas of application maintenance and development (mainframe/PL-1).

Other critical areas
Nishar asserts that Hexaware is also concentrating on application management outsourcing. But the real growth could come from a refreshingly new segment—R&D outsourcing. Under this segment, the company plans to build domain expertise in VLSI, chip design and embedded technologies, similar to a Sasken or a Wipro. Hexaware has already invested close to $1.3 million for setting up a R&D centre. Srinivasan believes this could be a great growth area for the company in the long term and expects around 4-5 percent of revenues to come from this sector in the next year itself.

Alliances are also a critical part of the company’s growth strategy. To win large contracts, the company has signed several strategic alliances with partners who are servicing Fortune 500 clients. For instance, Hexaware is providing offshore services for Exult’s leading clients such as Bank of America, Prudential Insurance, and Exult’s own operations on the PeopleSoft platform. In addition, the company is also directly engaged with PeopleSoft to support their e-Centre activities. Adds Srinivasan, “We are steadily increasing our market reach by forming multimillion dollar engagements with leading system integrators like IBM, Unisys and Valtech, and ASPs like PeopleSoft’s e-Centre and Transchannel. These alliances will open up growth opportunities in the application management, EAI and e-business areas.”

There has also been an increased focus on spreading business risk. For instance, Hexaware’s five biggest clients contributed 32 percent of revenues in 2001. Hexaware’s biggest customer contributed no more than 13 percent of revenues in 2001. Analysts believe this is a good de-risking model.

What all this brings us is to the critical question of where Hexaware is headed. The roadmap charted out by the management seems good enough to allow the company to not only stand on its own legs but also grow to become a top-rung software major. But for this plan to show results, to show that Hexaware can stand without Aptech, the Doubting Thomases need to give it some amount of time. If the plan succeeds, it will be a second feather in Nishar’s cap-the first being Aptech Training.