Is L&T’s hostile bid for Mindtree worth it?

Towering over Mindtree
Towering over Mindtree
Image: Reuters/Shailesh Andrade
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Mumbai-based Larsen & Toubro’s (L&T) plan to buy out Bengaluru-headquartered Mindtree has left many asking: Why is an 80-year-old engineering and construction company so interested in a mid-sized IT outsourcing firm that it is willing to risk a hostile takeover bid worth close to Rs10,700 crore ($1.6 billion)?

The answer, according to industry analysts, is straightforward: self-preservation.

“L&T’s five-year strategy for financial years 2016 to 2021 involves growing of their services business, apart from non-core divestment,” said Lavina Quadros, equity analyst at Jefferies India. Mindtree acquisition is in line with the management’s vision to increase the portion of services in its overall portfolio, in order to offset the volatility in major verticals such as banking and financials, Quadros added.

On March 19, L&T signed a deal (pdf) to buy a 20.32% stake in Mindtree from VG Siddhartha, owner of the country’s largest coffee shop chain, Café Coffee Day (CCD). He was the largest shareholder of Mindtree. L&T also announced plans to acquire a controlling stake in Mindtree through an open offer to public shareholders. The Mindtree management will meet today (March 26) to consider L&T’s offer, and also propose a share buyback program to counter the hostile bid, if possible.

Hostile takeover bids are not common in India, and L&T’s move upset many. “Mindtree has not been designed as an “asset” to be bought and sold,” the company’s co-founder and non-executive director Subroto Bagchi said in a tweet on March 17.

Well, the reality is that Mindtree can prove to be quite the “asset” that L&T needs.

The struggle

Mindtree was launched in August 1999 by 10 techies who had worked for several years at leading IT firms like Wipro, Lucent, and Cambridge Technologies. The leader of the pack was Ashok Soota, who had by then spent over 15 years at Wipro and was the company’s president at the time.

Mindtree was seen as the “poster-child of the new economy” after it became one of the first Indian IT services firms to be backed by venture capital investors. The first few years were great with revenues growing rapidly and the company expanding its team.

However, after the first five years, it got harder for Mindtree to meet revenue growth targets. In 1999, it first sought to touch $1 billion in revenue by 2009. By 2006, it decided to push the timeline to 2012. In 2009 it launched its new five-year vision statement moving its $1 billion revenue target to 2014.

The company has not reached the $1-billion milestone even now: In the financial year 2018 (pdf), total revenue stood at $846.8 million and net profit at $88.4 million.

There were several other jolts that kept pushing back Mindtree.

In October of 2009, the company announced its plan to design mobile phones equipped for fast-speed internet access using third-generation (3G) technology, on Google’s Android platform. However, a year later, it shelved the plan (pdf) saying the manufacturing business was challenging. This flip-flop cost Mindtree $8 million.

Then, in 2011, Soota stepped down and later set up a rival firm called Happiest Minds.

“If you look at the history of the company, they had one of the best management teams, but this team simply failed to perform. They have not taken the right decisions, even some of the acquisitions they have made have not done well,” an analyst with a Mumbai-based brokerage firm said, on conditions of anonymity.

Despite all these challenges, Mindtree has carved a niche for itself in the $167 billion Indian IT sector.

The sustenance

The past few years have been tough for the industry amid a changing technological landscape. Even sector leaders Infosys and Wipro have struggled to maintain high growth.

Mindtree survived, though, with a strategy that it began implementing way ahead of time.

It focused on digital technologies such as artificial intelligence and machine learning back in 2011, way before most rivals did. The early-mover advantage began to pay off by 2013-14.

It took sector leaders Tata Consultancy Services and Infosys a couple of years to move to digital technologies, which still make for only 25% of their overall revenues, according to DD Mishra, senior director at Gartner. For Mindtree, however, digital services will make for over 50% of its revenue by March 2019.

“Mindtree has been gaining traction with its capabilities around IoT. It brings edge analytics, digital technologies, DevOps, and digital agile capabilities to the table,” Mishra added.

The company has also witnessed consistent deal wins over the past three years. During October-December 2019, digital services contributed nearly 50% to consolidated revenues, up from 44% in the same quarter last year.

“Mindtree’s strong digital competencies, improving participation in large deals courtesy the advisory channel and portfolio alignment to growth areas will continue to drive above-industry revenue growth,” a Kotak Institutional Equities report said.

Fits like a glove

In a note, L&T CEO and managing director SN Subrahmanyan said his company was “probably the best home” for Mindtree in India.

“L&T Infotech is predominant in the banking, manufacturing, oil and gas, and insurance businesses, whereas Mindtree is into consumer packaged goods, retail, hospitality, travel and technology,” Subrahmanyan wrote, highlighting how his company’s tech business aligns well with the acquisition target.

A close look at the two companies’ financials reveals he’s probably right.

The combination of the two companies will help create an entity with a higher turnover of close to Rs12,000 crore, closer to larger rivals such as Wipro and TCS, according to Girish Pai, head of research at Nirmal Bang.

The Mindtree management, however, thinks differently.

“We do not see any strategic advantage in the transaction and strongly believe the transaction will be value-destructive for all shareholders,” the founders said at a press conference held in Bengaluru on March 22, to counter L&T’s hostile bid.