How will the Mindtree-L&T takeover battle pan out? Nine questions answered

The Mindtree founders want to retain their firm’s unique culture. And have chosen to strongly rebuff L&T’s takeover attempt. But as things stand, the odds seem stacked against the founders as they try to block the $18 billion megacorp from taking control. A prognosis of what could happen next

Indrajit Gupta

[By Chinmayee Mishra (CC BY-SA 4.0)]

(With NS Ramnath)

It had all the makings of a dream venture. In 1999, Subroto Bagchi and a team of well-regarded software professionals were contemplating launching a venture of their own. Around the same time, industry stalwart Ashok Soota was also exiting Wipro. An investor suggested the two groups join forces. That was how Mindtree came into being. From the beginning, idealism and a strong sense of purpose anchored in middle class values defined the company, making it one of the best places to work in the software industry.

Almost two decades later, the $846 million enterprise is faced with its biggest existential dilemma. Larsen & Toubro’s (L&T’s) decision to make a hostile bid to take control of Mindtree has sparked off a war of words that refuses to die down.  

The founders are understandably keen to preserve Mindtree’s independence and its unique culture. But in a capitalistic world, only money seems to matter. On its part, the L&T top brass led by its CEO & MD SN Subrahmanyan are at pains to assure the Mindtree team he will do nothing to disturb the independent status—at least for the time being. This is a big moment for Subrahmanyan too. Having taken over the reins in July 2017, SNS, as he is known, is emerging out of the shadows of AM Naik. Naik ran L&T with an iron hand since 1999 and left his firm imprint on the conglomerate.

The tussle is poised at an important juncture. Where will this takeover battle—the first of its kind in India’s IT history—end up? Do the founders have enough ammunition to ward off the raider? What’s the best way to resolve this conflict? Before we get there, take a quick whistle-stop tour of the story so far by looking at the interactive graph below.

[Timeline by NS Ramnath]

Q1 So what happens next?

The die is cast. Either on or before Tuesday, March 26, the L&T management will make a detailed public statement of its draft open offer filed with the Bombay Stock Exchange (BSE). L&T will also present a timetable for the open offer. The Mindtree board has convened its next board meeting on March 26. They will discuss the open offer and their original proposed board resolution on a possible share buyback.

And at least two days before the open offer begins, a committee of independent directors at Mindtree will need to evaluate the open offer on its merits and advise shareholders on whether to take the open offer or not.

Q2 What are the options before the Mindtree founders?

The four Mindtree promoters—Krishnakumar Natarajan, Subroto Bagchi, NS Parthasarathy and Rostow Ravanan—will get time to reflect on their next course of action. As things stand, their options are limited. Earlier on Wednesday, March 20, the Mindtree board meeting to discuss a possible share buyback was adjourned. Cafe Coffee Day (CCD) founder VG Siddhartha, who signed a definitive agreement to sell his 20.3% stake in Mindtree to L&T, sent a letter saying that he would not be able to participate in the buyback. And given the open offer might be around the corner, the board may have chosen to press the pause button. It looks highly unlikely that the Securities and Exchange Board of India (SEBI) rules will allow it to go ahead with the buyback. In any case, a share buyback can only raise the cost of the acquisition for L&T, but not actually prevent it.

Unless the promoters are able to bring in a white knight in the form of a private equity firm. But if that was on the cards, it ought to have happened much earlier. Here’s the upshot: No private equity firm worth its salt would agree to commit billions and then sit on the sidelines. And a buyout is the only way that a private equity player would have agreed to step in, not with a minority stake.

Q3 Did the founders underestimate the pressures on Siddhartha to sell his stake?

Possibly. Especially given that Siddhartha stepped off the board in March 2018, they had almost a year to find a solution. Given Siddhartha’s proximity to the founding team, it would have been well-nigh impossible for them to not know the mounting pressures facing the entrepreneur.

Siddhartha had pledged his entire stake in Mindtree to raise money to fund his business. In 2011, when he additionally bought Ashok Soota’s stake when he exited Mindtree, Siddhartha’s business portfolio was in fine fettle. His Cafe Coffee Day (CCD) and coffee plantation business was throwing up so much cash that he had to look for new opportunities to invest in. A story about the reclusive billionaire published in Forbes India in 2011 talked about his diversification into the furniture business, apart from a foray into logistics, hospitality and financial services.

Siddhartha’s entrepreneurial journey with CCD started on a very strong note, back in 1996. Over the last eight years, however, he faced a series of strategic challenges. Some of it was his own doing. Insiders talk about the three kinds of confusion: Whether they ought to target teenagers or corporate executives. And whether the cafe should have a large food menu or remain a quintessential place to hangout over a cup of coffee where food played an incidental role. And finally, more recently, it had to figure out how to respond to growing competition from home delivery models and new low cost rivals like Chaipoint and Chayoos.

Over the years, this confusion manifested itself in ad-hoc decisions over the look and feel of the stores (the vibrant, purple and red tones giving way to a sober brown, wood panelled look), expanding the food menu without commensurate investments in food kitchens and finally, a clearly sub-scale international operation. Plus, the rapid retail expansion ensured that there was a CCD in virtually every major mall. That took off some of the sheen. But over time, as Starbucks opened up, mall owners chose to give it the better locations, and CCD had to be content with the not-so-good locations. That certainly hit customer walk-ins, and the portfolio of stores that were losing money expanded. The vending machine business, especially inside large enterprises, on the other hand, continued to grow at a fast clip. But coupled with a downcycle in the coffee plantation business, the business eventually turned cash negative.

The result: Siddhartha began to face serious issues in paying back the nearly Rs 3,000 crore loans that he took from banks by pledging his shares in Mindtree. And ran the risk of defaulting and invoking the pledges. Plus, there was an issue with Income Tax authorities attaching a part of Siddhartha’s stake in Mindtree because of a tax raid in 2017 where they claimed to have found Rs 650 crore of undisclosed income.

Nearly seven months ago, KPMG’s Corporate Finance team led by its senior partner Srinivas Balasubramaniam brought the deal to the M&A and strategy team at L&T’s corporate centre for the first time. And that’s how L&T came into the picture.

Q4 So can they go back to the PE firms and renegotiate the deal?

Among the three PE firms that were said to be in the fray, Barings would have been a frontrunner, given its success with Hexaware. And a possible deal with NIIT, where the promoters have decided to step off. Eventually, a merger between Hexaware and NIIT is on the cards. The Mindtree founders apparently asked for a guarantee that Mindtree would not be merged with Hexaware. And insisted that Barings play a passive role, much like Siddhartha.

None of which would work for a typical PE firm.

And it may be too late to turn the clock back. Because any bidder starts with a disadvantage. L&T is already in the driver’s seat having bought Siddhartha’s stake and also announced that it was scooping up additional shares from the market. Picking up shares from the open market for a relatively illiquid stock like Mindtree would send the share price shooting up. And in the end, it would have to persuade L&T to sell its shares as well. If the Mindtree founders had agreed to sell their entire 13.32% stake to a PE firm, the PE firm could have possibly bought an additional 1.7% or a bit more from the open market and then attempted an open offer. But that’s where the founders’ intransigence to sell their stake and move to a managerial role (albeit with generous stock options) would have come in the way.

Q5 So is the takeover likely to proceed without a hitch?

It would seem so. But there is a fly in the ointment. There are unconfirmed reports that some of Mindtree’s top customers could exit, if the deal goes through. And that is a real threat for L&T. In the US and Europe, a committed customer is worth its weight in gold. It takes years to develop a client relationship. And since the Mindtree founders may have played a key role in nurturing these relationships, some turbulence on that front cannot be ruled out.

The issue with talent is less worrisome. IT Jobs are hard to come by. However, rivals could look to capitalise on some of the key skills, especially in digital. That’s why L&T’s Subrahmanyan has taken it upon himself to reach out to Krishnakumar at Mindtree and defuse the tension and invite him for a meal.

Q6 Should the founders look to renegotiate better terms with L&T?

That would seem like the only viable option left. But backing down from their hardened position may prove to be a tad uncomfortable and awkward. Especially after ratcheting up the battle with a strong emotional pitch. If the idea was to send a clear signal internally and to the larger industry that any takeover would be met with stiff resistance, it would have needed much more than emotion. Because, in the end, staving off an attacker with big bucks would invariably demand loads of capital.

On the face of it, it would seem that the Mindtree founders may have underestimated the threat of a hostile takeover and have been caught on the wrong foot. Which is surprising given that the writing on the wall was quite apparent at least a year ago, when Siddhartha stepped out of the board and signalled his intent to sell the 20.3% stake in Mindtree he held himself and two of his allied firms.

If push comes to shove, the chances are that L&T may need to up the offer price by at least 10-15% premium over the all-time high, up from the current offer price of Rs 980 a share to nearly Rs 1,200. That will guarantee that its open offer goes through successfully. Whether it is willing to up the ante remains to be seen and how the market responds to L&T’s moves also remains to be seen.

Q7 Could this deal prove costly for L&T in more ways than one?

It could. The L&T stock price has declined marginally, ever since the news of its bid became public. That is understandable. For one, its return on equity has seldom exceeded a measly 16%. (Its CFO R Shankar Raman has recently indicated that there will be concerted attempts to push up RoE to 18% by 2021.) And over the years, it has faced criticism over its capital allocation model and earned itself a conglomerate discount. In response, L&T has tried to streamline its structure, create independent verticals for each business. Some of them like L&T Infotech and L&T Tech now have their own boards. And L&T has exited non-core businesses like switchgear.

Now, the decision to use the parent company to buy Siddhartha’s stake in Mindtree has rightly come in for criticism. It opens up a Pandora’s Box on whether L&T will go back on its promises to streamline its structure. Experts say that L&T Infotech could have chosen to fund the deal through debt. Whether it has the bandwidth to manage two competing entities within the same conglomerate structure is anybody's guess.

Besides, the moot point is whether this M&A deal moves the needle for L&T Infotech. The two entities together are about a fourth of Wipro’s turnover of $8 billion, and about one-tenth of TCS’s size. And they still wouldn’t be among the top five IT companies in India. If size is now a critical determinant for bagging large global customers, it is unclear if this will make any difference.

But Mindtree’s current price earnings ratio is higher than Infosys and Wipro. And it remains to be seen whether L&T is forced to sweeten the deal further, thereby pushing up the cost of the acquisition.

However, while there may be debate over the means, the end goal is clear. L&T’s long-term positioning is to be a projects and service conglomerate. Unlike the inherent risks involved in the projects business, services tend to be less chunky and earn higher margin as well. And Subrahmanyan’s mandate from the board of directors is to increase the revenues from services through its two tech arms and L&T Finance. Even its real estate business is considered more as a service business. And it helps achieve a more well-balanced portfolio.

Q8 So does Mindtree bring anything distinctive to L&T Infotech?

Indeed, Mindtree is perhaps well ahead in the fast growing digital space. It helped create the tech backbone for Aadhaar. And its work on the cloud platform at Microsoft, and its business transformation projects at Marriott, AIA, Aviva, Ritz Carlton and P&G have been noteworthy.

Back in 2016, L&T’s strategy team at the corporate centre had called out digital transformation as an important driver of growth in the infotech space. By then, Accenture had already gained a huge head start over the rest from 2012 onwards. And by 2017, digital transformation emerged as a priority item because clients, to start with in the banking, financial services and insurance (BFSI) space, began to see their business get disrupted. Even the stock market was willing to offer a premium for software companies that earned a substantial proportion of their revenues from digital.

Under its CEO Sanjay Jalona, L&T Infotech has had some traction in growing its digital revenues. Jalona is based in New Jersey. And his newly hired COO Nachiket Deshpande from Cognizant will hold up delivery from India. Revenues for digital are called out separately at its board meeting. But there’s plenty of ground to be covered. Besides, there is considerable debate over what really constitutes digital. In many cases, lots of basic back-end work tends to get clubbed as digital. Because a higher share of digital revenue in the portfolio tends to fetch a higher premium in the stock market and from analysts like Gartner. (Some like Cognizant, for instance, only consider work that leads to a better customer experience or business transformation under the rubric of digital.)

When the enabling resolution came up for discussion in January this year, the L&T board did spend a few minutes to look at whether there were significant overlaps in the business and whether there was bandwidth available to manage another separate entity. At that stage, neither was there any talk about L&T being a frontrunner nor had the deal been perceived as hostile by the Mindtree founders.

Q9 So is the talk around a lack of a cultural fit significant?

The pedigree of the two software companies to a large extent determines their culture. The overhang of L&T’s manufacturing and engineering projects background has seeped into L&T Infotech. For a long time, L&T’s fledgling software business was single-handedly led from the front by its chairman AM Naik. And the culture was decidedly top down. There were frequent leadership changes at the operating team. And L&T used its clout as a conglomerate to source business for L&T Infotech. For instance, insiders say that Citibank was granted mandates for investment banking. And in return, Citi gave some of its tech work to L&T Infotech. Its manufacturing and its engineering background also meant that L&T made strides in old economy sectors like energy and automotive.

Headquartered in Bengaluru, Mindtree, on the other hand, has a decidedly more open and transparent culture. Each of the founders is well-liked and trusted not just inside but across the industry. And they have always been accessible to people. Despite business setbacks in the early years and again, midway through the billion dollar revenue journey, they’ve maintained their focus on building a culture based on camaraderie and trust. As Subroto Bagchi maintains in his emotionally charged letter to employees, as much as 16.67% of Mindtree’s equity has been given to employees, something that is pretty rare. Besides, their digital strategy has also now begun to deliver significant revenue growth.

One cannot rule out cultural incompatibility. However, if L&T sticks to its stated stance of running Mindtree independent for at least the next two years without disturbing the management team, that could help ease the anxieties of the founders and the wider Mindtree family.

About the author

Indrajit Gupta
Indrajit Gupta

Co-founder and Director

Founding Fuel

Indrajit Gupta is a business journalist and editor with over two decades of experience. He was the Founding Editor of the Indian edition of Forbes magazine. Within four years of its launch, Forbes India became the most influential magazine in its space.

He is the co-founder and director at Founding Fuel.

He has served in leadership positions at many of the leading media brands in the country. Before taking up the assignment to start up the India edition of Forbes magazine, Gupta was the Resident Editor of The Economic Times in Mumbai and before that, the National Business Editor of The Times of India.

Over the years, Gupta has built a reputation for grooming talent and creating highly energised and purposeful newsrooms. He has interviewed several leading global thought-leaders and business leaders including CK Prahalad, Ram Charan, Wayne Brockbank, Sumantra Ghoshal, Carlos Ghosn and Nitin Nohria, and also led cutting-edge joint research-based projects with McKinsey & Co, The Great Place to Work Institute, Boston Consulting Group, KMPG and Coopers & Lybrand.

He won the Polestar journalism award in 2010 and was awarded the Chevening fellowship by the British Foreign office in 1999. Gupta is an alumnus of the SP Jain Institute of Management and Research, Mumbai and a B.Com (Hons) graduate from St Xavier's College, Calcutta.

Gupta teaches a course on Business Problem Solving at his alma mater. He writes a column named Strategic Intent in Business Standard’s edit page. He lives in Mumbai with his wife and two young daughters.