Frontal Attack

The battle lines have been clearly drawn in what is probably the first hostile takeover in the Indian IT industry. On March 18, Larsen &Toubro (L&T) bought a 20.32% stake in Mindtree from Café Coffee Day founder VG Siddhartha for Rs.32.69 billion at Rs.980 per share, despite the promoters of the mid-tier IT services firm raising objection.

That’s not all, L&T is now looking to buy another 15% stake from the open market and has made an open offer for an additional 31% that would take its overall stake in Mindtree to 66%. It has earmarked Rs.107 billion for all three stages of the acquisition planned, valuing Mindtree at about Rs.162 billion.

This is L&T’s second attempt to acquire an IT services firm. It made an unsuccessful attempt to acquire the scam-tainted Satyam Computers in 2009 eventually losing that round to Tech Mahindra. However, this one looks like it is going to a protracted battle with the Mindtree founders resisting the transaction from the get-go. “The hostile takeover bid of Mindtree by L&T is a grave threat to the unique organisation we have collectively built over 20 years. We do not see any strategic advantage in the transaction and strongly believe that the transaction will be value destructive for all shareholders,” said Krishnakumar Natarajan, executive chairman, Mindtree, in a press conference held on Tuesday. In an emotional appeal to L&T, the founders asked the firm, "If companies like you behave with extreme hostility to first generation entrepreneurs what message are you giving to all start-ups in the country.”

But for L&T, the deal seems anything but hostile. Its top management maintains they see the deal to be value accretive not only for its own shareholders but also Mindtree’s, given their limited client overlap and complementary capabilities in digital, cloud and infrastructure management services. “We are trying to do this with pyaar (love) and will continue to look at this as something we are doing from our dil (heart),” said S N Subrahmanyan, CEO and managing director of L&T, announcing the transaction. The acquisition will help L&T increase the contribution of the services business from 20% to one-third of consolidated revenue, apart from better utlisation of the cash on their books (Rs.160 billion as of December 2018). The company also generates Rs.15 billion cash every quarter. Ever since their buyback plan of returning Rs.90 billion to its shareholders was rejected by Sebi, they have been looking at alternate options to put their cash to better use. And that’s when Siddhartha came to them with an offer.

But Mindtree founders are in no mood to listen. They are rallying forces, be it the employees or investors. In fact Subroto Bagchi, one of the founders who quit as the executive chairman in 2016 to head the Odisha Skill Development Authority, came back to Mindtree to join the other founders in their fight to thwart L&T’s hostile bid. In a letter addressed to the employees, he appeals to them to stay the course. “KK, Rostow, Partha [the other founders] and I were offered huge bags of money to give Mindtree away. We have respectfully said 'no' to their overture," read the letter. "Our polite refusal has been interpreted as foolish idealism. That, we are (sic),” he says, going on to add that selling Mindtree may be the convenient thing to do but it is not the right thing to do, and the founders will be the first line of defence on behalf of all at Mindtree.

The founders also claim for now that they have the support of large institutional investors, who hold about 20.2% of the company’s consolidated capital and, together with the promoter holding, they have about 33.52% of voting rights. Mindtree’s board met on Wednesday but failed to decide on the proposed buyback offer to fend off the hostile takeover by L&T. In a statement to the exchange, the company said, “The board considered the proposed buyback of equity shares of the company at its meeting held on 20 March. Following detailed discussions, the meeting has been adjourned to a future date. No decision has been taken in relation to the proposed buyback of equity shares."

Sebi stipulates that when there is an open offer announcement in play, the target company cannot come up with a buyback or any other proposal that would alter the capital structure without getting shareholders’ approval through a special ballot.  The special resolution needs at least of 75% of the votes to be cast in its favour for it to be passed through.  Also, even if they win the votes, the proposed buyback cannot be more that 25% of the paid-up capital and free reserves, which will not be enough to stop L&T. Their best bet will be to find a white knight to make an even compelling counter offer to L&T’s. And they have 21 days from March 19 to do it. When Ashok Soota, one of the founders wanted to quit the company in 2011 over differences with other promoters, it was Siddhartha who stepped as the white knight and bought out his stake. Now Mindtree needs to find another one and needs to do it quickly.

It’s been a takeover that has been brewing for some time now. It started when Siddhartha was looking for an exit stepping down from Mindtree’s board about a year ago. While the Mindtree founders have been in talks with private equity investors such as KKR and Barings Private Equity Asia who had evinced interest in buying out Siddhartha’s stake but the talks fell through with both firms wanting a controlling stake and the founders reluctant to relinquish control. Now with L&T now firmly in the fray to get a controlling stake, Mindtree will have to find itself a strong ally to take on the conglomerate's might and that may require the promoters to reconsider some of their previous conditions.   

What works in Mindtree’s favour is that the L&T offer price of Rs.980 per share is only marginally higher than the closing price of Rs.953 on March 20. Since the beginning of the year, the stock has gained around 10% as the takeover buzz kept getting stronger. With the investors sensing a hard-fought battle in the works, most are likely to hold on for a better offer. Nevertheless, L&T isn’t backing down. It has made it clear that the next step is to buy 26%, which would not only give them a controlling stake in the company but also trigger the open offer to acquire the additional 31% offer.

While L&T has maintained that both companies would be run as independent entities, in the long run, it doesn’t make sense to have them operate as separate entities. If L&T manages to pull off its hostile bid, there is no doubt that the promoters will leave the company and, with them, the company will see some exits at the senior level as well. With people continuity being critical in large accounts and Mindtree’s top 10 clients contributing 44% of overall revenue, culture differences and integration will be a challenge for L&T. But that is a risk that the engineering firm is willing to take.

While the emotions run high as the promoters resist control being taken out of their hands, continued support from investors will depend on the company’s ability to raise money from a white knight to take on L&T.  While the company has managed to generate good returns for its shareholders since its listing, investors will look to maximise their returns and will eventually go with the highest bid. With a lot more drama waiting to unfold, the story is far from over with more counter offers expected in the coming weeks.