Mindtree 3.0

L&T completes the first successful hostile takeover in Indian IT as Mindtree braces for volatility

From Left- A.M. Naik, Group Chairman, L&T; Krishnakumar Natarajan and Rostow Ravanan, Co-founders of Mindtree / Photograph by Lantern Camera From Left- A.M. Naik, Group Chairman, L&T; Krishnakumar Natarajan and Rostow Ravanan, Co-founders of Mindtree / Photograph by Lantern Camera

Mindtree founders Krishnakumar Natarajan and Rostow Ravanan met Business Today at JW Mariott in Bengaluru's Vittal Mallya Road, a stone's throw away from the Cafe Coffee Day headquarters. It was early April. The two sounded hopeful. They forwarded five reasons why Mindtree should not give in to the hostile takeover attempt by L&T, a conglomerate with interests in construction, manufacturing, engineering, technology and financial services.

Mindtree grew its revenues 18 per cent in 2018/19, double the industry's expected growth rate during the year. Investments made in the past were starting to show results. "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 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, forget a control premium. "Research says anywhere between 30 per cent and 37 per cent is the control premium that organisations pay when they buy a listed company. Here, you are paying 1-2 per cent more than the current market price - it is 20-30 per cent below 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.

By the end of June, the spirited resistance - which included a press conference, several public statements and aggressive tweets - had fizzled out. It all began when the promoter of Cafe Coffee Day group V.G. Siddhartha and Mindtree's largest shareholder with about 20 per cent stake wanted to sell out. He had been a patient investor in Mindtree for over two decades but rising debts in the coffee business forced him to L&T's doors. On March 19, L&T announced a share purchase agreement. The escrow account was colourfully called 'Project Carnation, Lotus and Marigold', possibly to indicate the three sellers - Siddhartha, Coffee Day Trading and Coffee Day Enterprises.

After acquiring the 20 per cent stake, L&T made an open offer to buy an additional 31 per cent. When the offer closed on June 28, it was oversubscribed by 116.47 per cent. L&T is now a promoter in Mindtree with 60.06 per cent shareholding 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 and as employees of the company. Along with the other founders, they asked to be de-classified as promoters.

The takeover raises several questions; the answers are inconclusive. The doubts raised by the founders remain relevant. We don't know how L&T will now deal with the existing management team. It is also not clear at what point will Mindtree be merged into Larsen & Toubro Infotech (LTI), L&T's IT services company that competes with Mindtree. What is evident, though, is that Mindtree is set to change in many ways. But first, a glimpse into its interesting past and how the founders lost control of the company they had painstakingly built over the last two decades.

The Past

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; it collected $6 billion. 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.

But why couldn't Mindtree founders find a white knight to save the company from the hostile bid? To find out, we stitched up accounts from various sources, including investment bankers, and it emerges that the founders lost too much time negotiating with potential buyers of Siddhartha's stake. They may have also underestimated L&T. This was L&T's third attempt at buying Mindtree. Anil Manibhai Naik, L&T's Group Chairman, isn't someone who gives up easily.

Ashok Soota recalls that merchant bankers approached him when Mindtree was in its sixth year of operations. "Merchant bankers bring these sort of stories to you and want to get them (the companies) together, then see if some sparks fly," Soota told BT during a meeting. A few years later, there was a second offer. "We said we are not open. That was the end of that story," says Soota.

L&T was keen to bulk up its IT services businesses. LTI 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 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 player," he adds.

Subsequent conversations with private equity players didn't yield much. According to another source, talks with PE firm KKR dragged on for quite some time as Mindtree executives were busy visiting clients in the United States. "Mindtree was cooperating on the face of it but the body language of some founders said 'we don't need you'," says the source.

In December 2018, Baring Private Equity showed interest. "It offered Rs 1,000 per share to Siddhartha without even meeting the management. However, the underlying assumption was that the promoters would cooperate," says a banker. Baring wanted more control for the 20 per cent stake. Mindtree wasn't too welcoming and agreed to give Baring only one board seat. By the middle of January 2019, L&T came back to Siddhartha again and said it was okay with buying the stake without management support. However, the new price would be Rs 980.

Around February, Mindtree realised it was running out of options and time. It changed its stance and approached KKR and Baring. The price indication KKR forwarded was Rs 800-850. Baring hadn't done due diligence, which takes four weeks. Before Baring could come up with a new offer, Siddhartha gave his word to L&T. "Siddhartha said it was too big a risk. What if the deal was shot down after four weeks by the Baring committee? He sold to L&T," says an investment banker.

A detailed questionnaire on the above sequence of developments was sent to Siddhartha, Mindtree, KKR and Baring. KKR responded saying "we aren't able to comment on market speculation. Hope to be more helpful next time." Mindtree did not respond. Neither did Siddhartha or Baring.

The Future

The deal sealed, how will L&T change Mindtree? While murmurs from L&T suggest they wouldn't ruffle too many feathers to begin with, others aren't so sure as Mindtree will require 'rightsizing' before a merger with LTI.

"L&T is a much more aggressive company, whether it is people, customer, management style. Mindtree is softer in its approach. L&T will re-look at the management, who is good and who isn't. It will rightsize the organisation," says Mindtree Co-founder Janakiraman.

This may be good for shareholders, he says. Companies need aggression when they reach a certain size. However, any shock therapy has both positives and negatives."Mindtree is in its adolescence. L&T may be able to mature it into a larger company. But this has its dangers. The organisation can go through a cultural shock," says Janakiraman.

Analysts agree with the co-founder. LTI, one of them said, runs on adrenalin shots while the Mindtree management tends to be more lenient on targets. "LTI is driven more by L&T's desire to build a scale business. Hence, it is far more aggressive in the large deals space," he says. LTI's revenues jumped 19 per cent to 1.3 billion in 2018/19; the year before, the growth was 17 per cent. The analyst says L&T would have mapped who to retain and who to let go by now. Since Ravanan has already quit as CEO, the hunt for a new chief is on. Media reports suggest that Rajeev Mehta, the former president of IT firm Cognizant, and Sudhir Chaturvedi, LTI's Whole-time Director and President, Sales, are being considered for the role of CEO.

Shriram Subramanium, Managing Director of corporate governance research firm InGovern, says Mindtree investors will have to endure three-six months of transition, which is likely to see a reconstitution of the board. "L&T will exert its influence through the board and set expectations for the new CEO and the CXO. For the senior management, the challenge will be to get comfortable with the changes and get back to business," he says.

So, what will L&T's mandate for the new CEO be? Apart from rightsizing, analysts indicate L&T will first look at improving Mindtree's profitability. Mindtree is operating at an EBITDA margin of 15.2 per cent. The average for other mid-tier companies is 17 per cent. LTI is at 19.2 per cent. The new CEO will also have to work with LTI to avoid overlaps, internal competition and make sure that there is give and take between both the organisations. In short, prepare Mindtree for an eventual merger with LTI.

"We could see participation in joint bids," says another Mumbai-based analyst who does not want to be identified. "While LTI's strengths are BFSI, manufacturing and oil & gas , Mindtree is stronger in hi-tech, retail - CPG and travel & hospitality verticals," he says. Mindtree is also ahead in digital revenues and automation. In its latest earnings release, Mindtree said "automation is playing a significant role in modernising our technology service delivery, enhancing both efficiency and speed-to-results for our clients. We had deployed 576 BOTs (software that acts autonomously) as of March 31, 2019."

Nevertheless, the lingering question remains. Will the bulking up plan, of merging LTI and Mindtree, help? While Rostow and Krishnakumar told BT that in these days of automation, capability, and not capacity, makes sense, others differ. Among them is Ashok Soota.

"Everybody needs scale. You need to continuously invest because every year theres a new technology in this business," he says. Over the last few years, IT companies have had to invest in Cloud, Mobility, Analytics, Big data, IoT and Blockchain, among others. "When you can invest more, you can build more use cases, you can build more prototypes, you can build your own intellectual property - all this requires money. Therefore, scale makes a lot of difference," he adds.

A former senior executive of Mindtree who does not want to be quoted agrees. "The opportunities of bidding for larger contracts are fewer given the current size of Mindtree. If there is an integration, the companies can chase more $100+ million deals," he says. Both Mindtree and LTI have one $100 million plus client. While LTI has five $50 million plus customers, Mindtree has just one. In comparison, TCS, Indian's largest IT services company, has 44 $100 million customers and 99 $50 million clients.

Despite automation, IT services remains a people business. Large deals require good sales and execution teams, besides a solid management. Considering the bitterness that preceded the deal, keeping employee motivation high, and causing minimal disruption, is a goal worth pursing for L&T. These could determine the success, or failure, of Indian IT's first hostile takeover.

@rukminirao; @goutam20