Mindtree versus L&T: A misguided resistance

In 2014, when the management of Bengaluru-based mid-tier IT services company Mindtree approached the management of engineering behemoth Larsen & Toubro, the latter didn’t show any interest. Four and a half years later, in November 2018, when Cafe Coffee Day and its founder VG Siddhartha approached the same company to sell his 20.41% stake in Mindtree, with an aim to shed a portion of his debt, L&T found the synergies in the move.

What followed was an audacious hostile takeover bid by L&T, which has one of its subsidiaries — L&T Infotech — already operating in the space of IT services in India. As the company entered into an agreement to buy Siddhartha’s stake in the Bengaluru-based tech company, it quickly followed it up with two open offers aimed at garnering 66.41% stake in the company.

The management of Mindtree, which had been, according to the sources, interested in selling their stake in 2014, now started showing resistance to L&T. However, much of the company’s resistance has been based on emotional appeal, rather than the business prudence.

At a presser last week, the founders of Mindtree came up with emotional questions, pitted against the bidder, rather than a counter-offer, which was being widely expected. The presser also saw the return of the company’s star-founder Subroto Bagchi — who left his job with the Odisha government, with an aim to “save the company”, he founded along with others way back in 1999.

However, the founders of the company did announce that they will go ahead with the buyback plan they had proposed earlier, only to delay the decision on the same within 24 hours.

However, experts say any attempt of buyback by Mindtree will be a futile exercise.

“Now it’s a closed door for them. Even if they announce the buyback, they will have to go back to the shareholders to get approval. So, it seems like a waste of an exercise,” Shriram Subramanian, MD at InGovern Research Services, a proxy advisory services firm told DH.

Section 26 (2-d) of Substantial Acquisition of Shares & Takeover (SAST) Regulations of the Securities and Exchange Board of India (Sebi) rules that upon the public announcement of an open offer, the board of the target company shall not implement any buyback of shares or affect any other change to the capital structure unless the approval of 75% of shareholders by a special resolution through postal ballot is obtained.

Some others like Amit Tandon of Institutional Investor Advisory Service (IiAS) also lashed out the Mindtree management for what he said they were “using the company’s money to hold on to their positions in the management.”

Number game

Experts view aside, the number game suggests that it would be difficult for the Mindtree management to get through. In the case of buyback, they would need the approval of 75% of its shareholders. However, L&T has agreed to buy 20.41% of the shareholding in the company — leaving the company to negotiate with just 79.59% of its owners.

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.

Even as market players are resting on the negotiating skills of L&T’s AM Naik, the financial feasibility of Mindtree’s buyback offer is questionable. “Right now the investors are divided into two camps. Plus you have to realise that AM Naik of L&T is far more astute in convincing people in what is good for the company. So that is why Mindtree held back,” a market insider told DH.

Going by the pure fundamental numbers, Mindtree’s cash reserves amounting to Rs 162 crore are a mere 5.1% of its net worth of Rs 3,165 crore as of December 2018. Also, in case of a buyback by Mindtree, it increases the stake of L&T in the Mindtree, in percentage terms.

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 Rs 980 per share to its shareholders, Mindtree would need a bulk of the money. In case, the company wants to buyback 5% shares, it would need in excess of Rs 804 crore — five times of its cash reserves.

Impending merger

Although, for now, L&T has no plans to merge its subsidiary —L&T Infotech — with Mindtree, advisories like Elara Capital and Motilal Oswal advise that a merger of the two companies will create a lot of synergies for the engineering behemoth.

According to a report put out by Elara Capital, the merger of Mindtree, with L&T Infotech is inevitable. “We believe this will inevitably lead to a merger of LTI and Mindtree, as L&T is unlikely to retain two listed entities with complementary capabilities in the same industry,” the report said.

The LTI-Mindtree combined entity will have trailing 12-months (TTM) revenue of $837 million in banking, financial services and insurance (BFSI), $520 million in hi-tech & media and $554 million in manufacturing, retail, and CPG.

In the case of BFSI vertical, TechM has a TTM revenue worth $662 million, which is 21% lower than the TTM revenue of the combined entity.

Similarly, in the case of hi-tech and media verticals as well, TechM has a TTM revenue of $356 million, which is 31% lower than the combined entity. However, the transition is not going to be that smooth.

The hostile takeover bid might have an adverse impact on the clients of the company, according to analysts.

“Risk to growth/relationship in one/multiple accounts cannot be completely ruled out, especially as the share of L&T starts to creep up and the promoters’ options start thinning out,” market advisory Motilal Oswal said in a research note.

Some of Mindtree’s top clients have had long-standing relationships with the company, and its founding leaders have been the face of the company, the report said. Top-10 clients contribute close to 44% of the IT company’s revenues.

As Mindtree management is trying to resist L&T take-over, market observers across the spectrum are of the opinion that the deal will go through after a month of tug and war.