Last week saw a first-of-its-kind hostile takeover bid in the Indian IT industry when Indian engineering giant Larsen & Toubro (L&T) brought 20.32% stake of Bengaluru-based mid-tier IT services company Mindtree from VG Siddhartha, its biggest shareholder and the owner of Café Coffee Day (CCD). L&T also followed it up with two open offers aimed at garnering 66.41% stake in the company.
Soon after the deal was signed, the four remaining founders of Mindtree: Krishnakumar Natarajan, Subroto Bagchi, COO NS Parthasarathy and the current CEO Rostow Ravanan, who together has 13.32% stake in the company called up a presser and called the takeover as “hostile.” They also announced their plans for a buyback.
However, many trade analysts have said that their reaction was more emotional than an effective counter response. They have also opined that any attempt of a buyback by Mindtree would be a futile exercise as the company’s cash reserves amount to just INR 162 crore, which is a mere 5.1% of its net worth of INR 3,165 crore as of December 2018. Meanwhile, L&T chairman A M Naik said his company was not seeking a hostile takeover of Mindtree and was open to talks with the IT services firm’s founders to allay their concerns.
What will be the immediate effect?
A lot of noise, for sure. Immediately after the takeover bid, on Friday, Mindtree’s share fell by 1.16% to INR 939.00 apiece on the BSE where as L&T’s share gained 1.54% to INR 1,394.00. The benchmark Sensex shed 0.58% to end the day at 38,164.61 points. This is, no doubt, triggered by the panic caused by an emotional response of the founding team. The markets will certainly shrug it off later.
In the case of a buyback, Mindtree would need the approval of 75% of its shareholders. However, L&T has agreed to buy 20.32% of the shareholding in the company—leaving the company to negotiate with just 79.68% of its owners. Here’s how the stakeholding pattern is at the moment:
As of now, the company’s management has claimed support of just 23.93% of the remaining 79.85% of the shareholders, which includes promoter group owning 13.32% stake and Singapore-based Nalanda Capital, which owns 10.61% stake in the company. A buyback of 5% of the company’s shares would result in an increase in L&T’s holding in the company by 5.3%, while 10% buyback would increase it by 11.1%.
This is because the total number of outstanding shares comes down as a result of buyback. At the same time, if the promoter group doesn’t tender shares, their ownership will also go up to 14.03% from the current 13.32% in the case of 5% buyback of shares. In the case of 10% buyback, their shareholding will go up to 14.8%. Also, to offer a better deal than L&T’s INR 980 per share to its shareholders, Mindtree would need a lot of money.
In case, the company wants to buyback 5% shares, it would need in excess of INR 804 crore — five times of its cash reserves and hardly an efficient use of cash now.
Fear of merger and its effects
L&T owns L&T Infotech, and though the engineering conglomerate has said that they would maintain Mindtree as an independent entity, many trade analysts are of the opinion that a merger is inevitable as L&T is unlikely to retain two listed entities with complementary capabilities in the same industry.
They have also raised concerns about the future of the 20,000 employees of Mindtree, and the fitment between two culturally diverse companies in the event of such a merger. Mindtree has an informal culture with many of its employees addressing its founding members led by CEO Rostow Ravanan by their first name, where as L&T’s culture is based on the traditional command-and-control and top-down management.
Also, it’s not clear whether some of Mindtree’s business will be carved and farmed off to L&T Infotech Ltd. It’s also being speculated that this sudden change in institutional culture could lead to a churn among senior management ranks and may even lead to a few exits of executives overseeing large client accounts.
This could eventually hurt Mindtree’s clients, many of which contrast with that of L&T Infotech. Mindtree’s largest clients include Microsoft Corp., Southwest Airlines Co., Marriott’s Hotels Ltd., and Procter and Gamble Co., whereas Citibank Inc., Barclay’s Inc., Nordea AB, Chevron Corp., and General Electric Co. form the major client base for L&T Infotech. The 10 largest clients of Mindtree account for 44% of their total business.
What this could mean to Indian IT sector?
Again, nothing. At Tech Mahindra, we successfully completed a merger, although in completely different circumstances. This fight though is good for the minority shareholders who see their value rise as the bids notch higher. So do clients who will benefit from “the coming together of mid-tier IT services firms to form a larger company to deliver increased breadth and scale”, as a Forrester analyst noted. It is of course also important to keep in mind that mergers are hard to execute.
Other mid-sized IT firms may even find reason to rejoice. “Particularly those backed by PE players as there seems to be a meaningful upside and momentum,” Grant Thornton’s Shankar said. Reports suggest that Baring PE Asia may buy NIIT at up to a INR 10,000 crore valuation, albeit not in a hostile manoeuvre.
As the Mindtree management resists L&T takeover, market observers across the spectrum are of the opinion that the deal will go through after a month of tug and war. The minority shareholders will have much to gain. After that, it will be business as usual, because both of them are experiencing strong momentum currently—notwithstanding all talk of culture. Both have a high proportion of revenues coming from digital (50% for Mindtree). In the final analysis, it does not seem to be a bad deal for either party. Execution makes all the difference.
