L&T’s Hostile Bid for Mindtree: Evaluating Third Party Risks
Written by Vandana Mohanchandran
Mindtree, a technology and outsourcing company, was incorporated in the year 1999. Venture capital firms Walden International and Sivan Securities funded the company, later joined by the Capital Group and Franklin Templeton. The company deals in e-commerce, mobile applications, cloud computing, digital transformation, data analytics, enterprise application integration, and enterprise resource planning.
In February 2019, VG Siddhartha, Founder of Café Coffee Day, the largest shareholder in Mindtree, opted to resign from his position as Mindtree’s Non-Executive Director. Siddhartha owns a 20.45% stake in Mindtree, both directly and through two Coffee Day Group entities. He has been part of the company for the past 18 years, during which period, he gradually increased his stake.
Siddhartha approached L&T to acquire his stake in Mindtree, which is also expected to announce an open offer to buy an additional 15% stake in the company, amounting to a total of 31% stake. However, Mindtree was not amused by the idea of a conglomerate taking over a startup like Mindtree.
L&T’s Experience in Takeovers
L&T Infotech’s focus is primarily on BFSI with clients like Microsoft, Citibank, and Barclays accounting for most of its business, while Mindtree has made a quick transition into digital solutions, which is considered a key growth area for IT services. L&T Infotech’s growth prospects hinge on an inorganic strategy, similar to that of Tech Mahindra’s acquisition of Satyam.
In 2009, L&T had made a strategic bid by increasing its stake in Satyam to 12%. However, when Satyam’s scandal became public, L&T was lucky to get an exit through Tech Mahindra. Earlier, in 1989, Dhirubhai Ambani had made a hostile bid to take over L&T. During this time, L&T had contested vigorously and used its institutional investors to resist the deal.
Mindtree has been evaluating multiple options to avoid L&T’s hostile takeover bid. Mindtree’s promoters are looking to secure a place for themselves while negotiating with L&T. However, Mindtree’s promoters only hold a 13.32% stake in the company. It is presently unclear whether Mindtree’s investors backed the management in buying out the stake from Siddhartha.
Mindtree could opt for a buyback of up to 10% of its free reserves without shareholder approval. Mindtree has around US$0.41 B in reserves, implying the company can use the amount for the buyback of the company’s shares and then use a further US$0.1 B from the reserves for another 25% stake to retain control.
Unlike L&T, Mindtree does not have large institutional shareholdings. Hence, the obligation will be on the government to intervene. There should be a middle path where L&T is allowed to hold a passive stake and Mindtree retains its independence.
Gains from the Acquisition
In the medium to long term, collaborative gains will flow. It would scale L&T Infotech’s business. On a nine-month basis, FY19 financials of the combined revenue of L&T and Mindtree would be close to US$1.7 B, becoming the 6th largest in the industry.
In terms of verticals, L&T is expected to gain as Mindtree has a strong presence in technology, media and services (close to 40%) and the rate of growth in digital is very high. Mindtree’s share of digital services toward its total business is much higher at 49.5% compared to 37% for L&T.
Mindtree’s revenue per employee is slightly higher than L&T. However, L&T has been reporting a much better operating margin of close to 20% compared to 15% for Mindtree. Additionally, L&T has a record high utilization rate of 82% (compared to 74.6% for Mindtree). Synergies can lead to improvement in Mindtree’s margin performance.
Impact on Share Prices
Mergers and acquisitions typically boost the shares of the target company and weigh down the shares of the acquirer. It is no different in this case.
Post the announcement of L&T’s plans to buy a large stake in Mindtree, it witnessed a fall in the value of its software services arm. L&T’s valuation has fallen nearly 11% since mid-January, on fears that the acquisition drags down its performance. Meanwhile, Mindtree’s shares have risen about 7% in the same period, adding to gains since October last year.
This is the Indian IT Services industry’s first hostile takeover.
Mindtree requires an investor offering which can counter L&T’s offer. At present, there have been no such offers so the promoters are left with no choice but to leave it to shareholders to decide on change of control. It is assumed that L&T could manage Mindtree better than the existing promoters in terms of corporate governance.
The effects of a hostile takeover can be unfavorable to the talent pool. The exit of Mindtree’s senior management could lead to higher attrition rates. Such issues stem from a merger of contrasting cultures. L&T’s culture is known to be based on command-and-control and top-down management. In addition to this, 20,000 Mindtree employees may face an uncertain future, as it is not clear if Mindtree will be merged completely with L&T Infotech or in part with Larsen and Toubro Technology Services Ltd, L&T’s IT firm.
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