L&T’s Hostile Takeover of Mindtree: Is there Value for Shareholders
The Origin:
The idea of Mindtree came by chance, Krishnakumar Natarajan says in a video on the making of the company. He had invited Subroto Bagchi, his colleague at Wipro, for lunch and the two ended up discussing “what is it that they would be most excited to do?” Mindtree was born in 1999 with 10 co-founders, which included well-known names of the IT industry – besides Natarajan, Bagchi, Ravanan and Parthasarathy, there were Ashok Soota, Anjan Lahiri, Scott Staples and Janakiraman Srinivasan, among others.
Over the next two decades, the company survived many nightmarish scenarios. The dotcom bust of 2000-2001, when it lost many start-up customers overnight; the financial crisis of 2009 after the collapse of Lehman Brothers; internal disputes of 2010/11 when Ashok Soota, the chairman, quit and started a competing firm, Happiest Minds. The company also missed its revenue goals. Around 2008/09, Mindtree said it wanted to be a billion dollar company by 2014. It crossed the mark five years later, in 2018/19.
All this while many of the co-founders rallied behind the idea of Mindtree and ensured many highs. The year 2007 was a watershed. The firm wanted to raise $54 million from an Initial Public Offer (IPO); it collected $6 billion. In that, IPO the company allotted 16.67% of its shares to its employees. Which is strong signal of its culture and riorities.
Despite being a mid-tier company, it bagged interesting projects such as the application development and maintenance services contract for the Unique Identification project, later named Aadhaar. The company nurtured a culture that was different. It was perceived as a compassionate company. Many called it a ‘curd rice’ firm, formed by first generation entrepreneurs from humble backgrounds, many from south India. Bagchi’s father was a junior government employee in Odisha; Janakiraman’s father was a village postmaster in Tamil Nadu.
The ‘curd rice’ company’s co-founders, however, didn’t anticipate a hostile takeover bid. “We didnt plan for such scenarios. We were naive,” says Janakiraman. He quit Mindtree as Chief Technology Officer in 2014 to start Nuvepro Technologies, a product start-up, which is a spinoff from Mindtree.
VG Siddhartha (VGS) the Uncanny Investor:
It is said that there are few dealmakers as shrewd and savvy as VGS in southern part of India. From buying plantations in Latin America to logistics companies in India, driving a hard bargain with landlords for his coffee chain or with marquee funds, he sniffs a good deal from the look of it. But he had always been the silent partner in Mindtree. He backed the Mindtree founding team, when they, led by former Wipro vice-chairman Ashok Soota, wanted to start a next-generation IT services company, way-back in the late 1990s.
He initially took a 6.5% stake and provided office space to the nascent company. The firm went public in 2007, when it hit a revenue of around $100 million. Over the years VGS’s stake swelled to 20.4%.
“Even when the Mindtree management would miss its quarterly targets, it’s unlikely he would criticise them,” said a Bengaluru industrialist. “During this takeover tussle, both parties would still meet over coffee at least once a week at the Coffee Day headquarters.” But by 2018, Siddhartha wanted cash to pay off debt and expand other businesses. Monetising his tech and real estate investments seemed the best way out. “Siddhartha had committed to be a long-term investor. Now it’s nearly two decades,” said a person close to him. “His core business has been under pressure and (he) wanted to give adequate time to sell his stake,” added another associate.
When Siddhartha stepped down from the Mindtree board on March, 2018, it presaged the exit, but Ravanan said it was because the former wanted to focus more on his own businesses. Then, on February 7, 2019, Siddhartha went public with what had become an open secret.
The bankers first approached V.G Siddhartha with L&T’s interest in September 2018. Siddhartha had quit the Mindtree board in March and, according to sources, made it clear to the founders that he wanted to exit. “That was one of the reasons he quit the board. If you are on the board, you cannot sell at certain times due to access to insider information,” says a banker who does not want to be quoted. “L&T offered Rs 1,150-1,180 per share. The condition was that the board should pass a resolution blessing the transaction. Siddhartha called the founders for dinner to discuss this. The founders said don’t sell to L&T but find a Private Equity (PE) player,” he adds.
Winter had set in by the middle of December 2018 when Mindtree’s management agreed to meet executives of Baring Private Equity a prominent PE firm in Bengaluru. The founder- managers, with a 13.2% stake, were looking for a white knight to save them from a predator. In the middle was a passive investor, with a 20.4% stake, who wanted to cash out.
The meeting at The Leela Palace was cordial to start with. Mindtree was represented by three of the four founders — then chairman Krishnakumar Natarajan (KK), NS Parthasarathy and chief executive Rostow Ravanan — along with chief financial officer Pradip Menon.
Café Coffee Day founder VG Siddhartha, known to friends as VGS, was present. With liquidity pressure on his diversified business portfolio, he had been looking for a buyer for his one-fifth stake for the past few months. He stayed for introductions and left soon after.
Jimmy Mahtani and Hari Gopalakrishnan, the two managing directors spearheading the private equity practice of the firm in India, represented Baring. The PE fund acquired Hexaware, a mid-tier IT services firm of India and was looking for more. However, the two sides could not agree to a broad contour.
Baring was not the first private equity fund the Mindtree management engaged with, at least two months earlier, KKR had been in discussions to buy out Siddhartha, but didn’t make headway. The existing promoters were looking for passive investor like VGS, however all PE players were more aggressive in their stance. For example, Baring, made it clear that it was looking for board seats, management information system (MIS) statements, affirmative rights and a proactive role. KKR’s demands were similar. As a result there were expectations mismatch from both the sides
Team Mindtree wanted to know if Baring would want to merge the company with Hexaware. Despite assurances that both would be run independently, the Mindtree team wasn’t too flexible on the Baring demands at that point.
Finally VGS struck a deal to sell his entire 20.4 % stake in Mindtree to Larsen & Toubro (L&T). L&T in turn is seeking an additional 15 percent from the open market and another 31 percent from institutional shareholders taking the total to as much as roughly two-thirds of Mindtree.
“The people at Mindtree, the ‘Mindtree Minds’, have signed up for a mission, and not just a salary,” Ravanan said at a press conference in Bengaluru on March 19, 2019 a day after L&T announced its deal with Siddhartha. Echoing the same sentiment some Mindtree minds(as they are called) started social media(including twitter) campaign to oppose the acquisition.
They argued that Mindtree possess an unique culture which will destroyed if it is acquired by a big conglomerate.
The founders appeared to have five pronged objections to L&T aggressive takeover bid. Firstly, their argument is Mindtree grew its revenues by 18 % in financial year 2018-19, double the industry’s expected growth rate during the year. Investments made in the past were starting to fructify. “The real benefits will accrue over the next one or two years. If you disturb the equilibrium, the stakeholders will lose out,” said Natarajan.
Next, they cited the failure rate of acquisitions. “Every study, across industries, has found that only 20-30 per cent of Merger &Acquisitions (M&As) work. If we go back to people-driven IT services type of acquisitions, we are not able to see any history of large IT services acquisitions working,” said Natarajan.
The third objection was strategic; a bigger size is not relevant in IT services any longer as customers buy based on capability, not capacity.
The founders also appeared agitated at L&T not paying fair value. “Research says anywhere between 30 % and 37 % is the control premium that organisations pay when they buy a listed company. Here, you are paying 1% -2 % more than the current market price – that translates into a 20-30 per cent discount of the historic price,” said Ravanan. The founders’ last objection had to do with the fact that “culture can eat strategy for breakfast”. Disturbing the culture of Mindtree would impact the results, they said. “Mindtree is a high-performing system. There is nothing wrong with it. Just because of a problem at the shareholder level, putting the entire company at risk is bad for all shareholders. But fundamentally, you shouldn’t buy something that doesn’t want to be bought,” said Ravanan.
On March 19, 2019 L&T announced a share purchase agreement. The escrow account was colourfully called ‘Project Carnation, Lotus and Marigold’, possibly to indicate the three sellers – VGS, Coffee Day Trading and Coffee Day Enterprises.
Subsequently L&T made an open offer to buy an additional 31 per cent. When the offer closed on June 28, 2019 it was oversubscribed by 116.47 per cent. Subsequently L&T became the promoter of Mindtree with 60.06 per cent stake in the company. On July 5, Natarajan who was the Executive Chairman, N S Parthasarathy, the Executive Vice Chairman and Ravanan, the CEO and Managing Director, submitted their resignations as members of the Board of Directors of Mindtree as well as employees of the company. Along with the other founders, they asked to be de-classified as promoters.
L&T was keen to bulk up its IT services businesses for quite some time. L&T Infotech, the IT arm of the conglomerate reported a revenue of $1.3 billion in 2018/19. Together with Mindtree, with $1 billion revenue, it wanted to be a greater force to reckon with. It swiftly logged in when Siddhartha wanted to log out.
The Background at L&T:L&T has found itself in a position where it has a lot of excess cash. The Indian engineering giant wants to channel this cash into creating higher growth rates. Acquiring Mindtree in its view gave it an opportunity to earn higher Return on Equity (ROE).
Excess Cash and the Failed Buyback Bid: L&T had more than $2 billion in cash reserves. The company is expected to add another $1.5 billion in terms of free cash flow by the year 2020. This excess cash is currently invested at a rate of 5%. This is obviously dragging down the overall return on equity for the company.
It is important to note that Mindtree was not the first choice for L&T when it came to deploying these additional funds. Instead, the company wanted to buy back outstanding shares from the market. This $1.5 billion bid was foiled by the Securities and Exchanges Bureau of India (SEBI) (the Indian capital market regulator). The regulator did not allow the buyback offer to go through. SEBI objected because, after the buyback, the debt to equity ratio of L&T would have crossed 2:1. This is against the compliance norms laid down by SEBI.
L&T was not left with too many other options either. The company has already been paying excess dividends. The Dividend Payout Ratio (DPR) in the year 2016 was a whopping 33% and increased marginally to 33.59% as on 2019. The problem with raising dividends is that they set expectations for the future. Hence, if dividends are raised still further, they cannot be reduced in the future without a sharp reaction from the market. This is the reason why L&T did not choose to take the dividend route.
Offloading Non-Core Assets: L&T is one of India’s largest conglomerate. It had a revenue base of INR 857.82 billion as on financial year 2018-19.
L&T is also under pressure to increase its ROE. The company’s ROE has fallen from 24% to as low as 9% in the past decade. L&T has stabilized its ROE at a respectable15% at the moment. However, the shareholders are hungry for more. This is why L&T is being forced to sell off non-core assets and deploy the proceeds in high margin business like the information technology industry. The management’s guidance is going forward the company’s ROE will hover around 18%.
Big Institutional Investors Sold Out to L&T:
Nalanda Capital, a Singapore-based Foreign Institutional Investor (FII) agreed to sell its entire 10.61% stake in Mindtree Ltd to L&T. SEBI issued a show cause notice to Nalanda Capital for asking Mindtree’s public shareholders to refrain from selling shares to L&T in the ongoing open offer at ₹980 per share.
Two persons directly aware of the matter confirmed this development to the press. However, it is not known, whether the stake sale is related to the show cause notice.
SEBI served a show cause notice to Pulak Chandan Prasad-led Nalanda Capital, asking the company why a penal action should not be taken against it for behaving like persons acting in concert (PAC) to thwart L&T’s open offer, without making a counter open offer.
Even though Nalanda Capital has now sold its entire stake to L&T, the Singapore-based firm, has to mandatorily reply to SEBI’s show cause and clarify on its actions to save itself from potential penal actions by the market regulator.
“SEBI has asked Nalanda Capital on what basis it had told Mindtree’s other public shareholders that L&T should offer a price 20% higher than ₹980 per share. Nalanda Capital has been asked to clarify that being an FPI, which SEBI regulation empowers it to advise a shareholder in any investee company in India on any such share sale,” said the person, who is directly aware of SEBI’s processes.
The regulator’s notice follows complaints from Mindtree’s investors last week, alleging Nalanda Capital of attempting to prevent the information technology company’s shareholders from selling shares to L&T in the open offer.
On 10 June,2019, The Economic Times first reported that a handful of institutional investors of L&T, Mindtree and in some cases both, have written to SEBI complaining against the founder of Nalanda Capital for allegedly provoking the minority investors of Mindtree to spurn L&T’s offer.
On 20 June, 2019 proxy advisory firm InGovern Research, wrote to SEBI, urging the regulator to enquire into the matter as Nalanda Capital’s actions could be significantly detrimental to the interest of minority shareholders of Mindtree. InGovern, in its letter to SEBI, said it represents the interests of several minority investors (mutual funds, HNIs) of Mindtree, who are aggrieved at the actions of Nalanda Capital.
On June 7, 2019 L&T announced the open offer for Mndtree to acquire additional 31% stake at INR 980 per share. At htat point of time L&T had 28.90 stake in the company. The open offer closed on 28 June, 2019.
Post acquisition of VGS’s stake L&T started tightening its screw in Mindtree. It asked for board seats for three of its senior executives, Mindtree also appointed two additional independent directors. i.e. Prasanna Rangacharya Mysore and Deepa Gopalan Wadhwa as independent directors post L&T takeover. While Prasanna is a former chief legal officer of L&T, Wadhwa is a former ministry of external affairs official.
Incidentally the independent directors of Mindtree said that the L&T’s offer is acceptable. “The shareholders of the target company are advised to independently evaluate the open offer and take an informed decision about tendering equity shares held by them in the open offer,” the independent directors said in a filing with the Bombay Stock Exchange. The independent directors’ panel of Mindtree had further said that L&T’s open offer price at Rs 980/share appears “fair and reasonable”. The committee cited the closing market price of Mindtree shares on the stock exchanges on June 10, being “lower than the offer price” and said that L&T’s offer price of Rs 980 a share is in accordance with the regulations.
Mindtree shares closed at Rs 975.50 a piece on National Stock Exchange (NSE) and Rs
974.65 a share on Bombay Stock Exchange (BSE) as on June 12, 2019.
L&T, on 17 June,2019, launched its 10-day long open offer to buy 31% stake from public shareholders (including Nalanda Capital) in Mindtree at ₹980 per share.
Amansa Holdings Pvt Ltd, another leading institutional investor of Mindtree had sold its entire 2.77% stake to L&T.
L&T’s majority ownership along with management control marked the India’s first-ever hostile takeover in the IT industry.
This takeover also sparked a huge churn out in the upper echelons of Mindtree. All the promoter managers left their executive roles immediately after the L&T’s takeover. Other notable resignations were of Kamran Ozair who was the Executive Vice President, and an employee since inception. He was responsible for P&L, strategy and execution of the enterprise service lines in the company and he was based out of Mindtree’s US headquarters in Warren, NJ.
Anecdotal evidence shows that Indian conglomerates are seldom successful in building a well-functioning IT outsourcing business based out of India. One of the key reasons is the basic difference in culture between traditional manufacturing business houses and the IT outsourcing firms. The only notable exception to this is the India’s largest conglomerate the Tata group and to some extent Mahindra group. Therefore, it will be interesting to note how Mindtree is managed in the days to come. A pointer to this direction is L&T under the stewardship its legendary chairman AM Naik hired IT industry veteran and ex-Infosys top honcho Sanjay Jalona to run L&T Infotech another IT arm of the conglomerate. Post Jalon’s appointment, the company showed noticeable improvements in its performance. Continuing this trend, L&T appointed Cognizant veteran Debashis Chatterjee as the new CEO.
In the 20th.Annual General Meeting (AGM) held in immediate aftermath of the hostile takeover, L&T management wanted to soothe the frayed nerves of the Mindtree shareholders L&T Managing Director and CEO S N Subrahmanyan told the shareholders that Mindtree is not snatched by force, they perceive that the company has now become part of a bigger family. In the same AGM, L&T’s legendary chairman AM Naik was also appointed as the chairman of Mindtree’s board.
Required:
- Introduction
- Facts
- Analysis
- Problem & Solution
- Conclusion
- Recommendation