The New L&T
By Nevin John and P. B. Jayakumar June 14, 2016
Larsen & Toubro Chairman A.M. Naik first noticed S.N. Subrahmanyan, an enthusiastic civil engineer then heading the construction of the Bangalore airport, about 12 years ago. Until then Subrahmanyan had played key roles in marquee L&T projects such as the Lotus Temple in Delhi, Abu Dhabi airport, police headquarters in Iraq, and Hyderabad HITEC City. Naik's first impression was that he was 'arrogant'.
He must have flashed back 40 years, when Naik himself appeared for an interview for a job at L&T, he was considered 'overconfident. Naik got the job, though at a lower pay, but went on to become the company's Chairman. Subrahmanyan is set to get the job too.
For, Subrahmanyan took the criticism of the super boss to his heart and initiated a correction phase. "I became introspective. Every evening I stood before the mirror and thought about my contributions to L&T. This helped me stretch my abilities," notes 56-year-old Subrahmanyan, the likely successor to the septuagenarian Naik, who has been at the helm for 17 years.
Barring exceptional circumstances, Subrahmanyan is likely to be anointed by L&T's board as the next managing director & CEO. But the company he will inherit and run until it's time to pass on the baton will be a vastly different entity from the one he takes over from Naik. In short, Subrahmanyan's L&T will be nothing like Naik's L&T!
Under the scanner are plain vanilla operational assets such as roads and power plant and non-core businesses - valves and alloy. After development, L&T is unlikely to operate Hyderabad metro and Seawoods commercial complex. In favour will be new thrust areas such as smart city, nuclear, defence and railways.
For, Naik has already set in motion a five-year exercise for L&T's makeover. A plan to make it a leaner, more focused organisation that will engage more in hi-tech and specialised projects rather than build highways. The move will reduce the number of companies within the fold from 21 in 82 businesses to 15 across 65-70 businesses through divestment, merger and new subsidiaries. It is a significant departure from L&T's old way of doing things.
But let's come back to that in a bit.
Subrahmanyan's elevation will be after years of speculation over: After Naik, who? Around the time Naik turned 65, the age of superannuation, in 2007, L&T had little option but to retain him due to a lack of succession planning at a time when it went through one of its most critical phases of retirement of key personnel. As a result, Naik, who built L&T from a mid-sized construction company into the multi-sector engineering and technology giant it is today, got two five-year extensions post retirement - until 2017. Towards the end of Naik's first extension, J.P. Nayak, president of machinery and industrial products, who was the strong second-in-command in L&T's hierarchy, retired in 2011/12, along with K.V. Rangaswami, the head of construction. Another contemporary, CFO Y. M. Deosthalee, moved to L&T Finance as chairman in 2011.
Of late, despite his stellar reputation and career, analysts and the board had worried about L&T's succession planning. Naik's reluctant decision to hand over the reins may appear like an exercise in self interest, but few can blame him for that. After all, who could manage a company of the size and complexity of L&T, but the man who created it - Naik himself. Subrahmanyan says Naik is a person beyond normal abilities: "He doesn't waste any time. Naik does networking at the highest level. He regularly meets the mighty and the powerful in the world." Since Naik took charge, L&T's revenues have grown 20 times and market cap 45 times (see interview on page 52). Only, age doesn't favour him any more.
In comes Subrahmanyan. The Deputy MD and President already heads the company's biggest vertical of infrastructure and construction (I&C), which contributes 47 per cent to L&T's Rs 1,03,522 crore revenue. L&T has not officially made the announcement of Subrahmanyan's appointment as the next CEO. However, Naik says Subrahmanyan is the senior most, after him. "So the chances of him becoming the next boss are higher," he says.
Besides I&C, Subrahmanyan is entrusted with L&T Infotech, L&T Technology Services, the shipyard and Hyderabad Metro, besides L&T's 'Smart World' business. "In the last couple of years, I have entrusted him with critical responsibilities. Until now, I have given him four businesses in addition to I&C. By July 2017, I would give almost every business to him," says Naik, who would stay as chairman or chairman emeritus sans any executive role.
Sanjay Sethi, Managing Director and CEO of Nestor Consulting, says that L&T's size and complex business structure demands clarity in succession. "The successor should get the time to learn working with Naik. The sooner the company nominates a successor, the better," he adds.
In the true sense, heading L&T is like making an elephant obedient. It has no promoters. It is vast, and complex. It builds infrastructure such as roads and airports on one hand, and nuclear plants and missiles on the other. And, unlike the Internet companies in vogue today, it is firmly planted in the brick-and-mortar economy. Somewhat like FMCG giant ITC, L&T's ownership is mainly with public sector insurance companies and banks, in addition to the 12.58 per cent stake held by the employees' trust, which Naik made to ring fence L&T from hostile takeovers. Former Union Finance Minister P. Chidambaram once rightly termed L&T as a 'national sector' company. If India has a Bechtel, Vinci SA or a Grupo ACS, it is L&T.
L&T Of The Future
Meanwhile, L&T's makeover is already in the works. In two years, it has sold off the port in Dhamra (Odisha) to Adani group and signed an agreement for selling Kattupalli (Tamil Nadu) port with them. Kattupalli would fetch around Rs 2,000 crore, while the JV with Tata Steel at Dhamra was valued at Rs 5,500 crore. In 2012, L&T sold its medical equipment business to Skanray Healthcare. The company's move to sell off its electrical & electronics business at a valuation of close to Rs 10,000 crore had been objected to by financial Institutions such as LIC since the business makes profits.
Five businesses will be spun off, just like L&T Finance was. L&T Infotech, L&T Technology Services and, four years down the line, L&T Hydrocarbon will form as daughter companies. Altogether six to eight companies will go out of the parent company and the remaining businesses within will be grouped into verticals like water, electrical transmission and distribution, infrastructure, heavy infrastructure and transportation infrastructure. Smart World and Communication is another vertical that has the potential to become an independent business in future.
Last year, L&T decided to put the sale of its subsidiary L&T Valves on the backburner after failing to fetch the desired value of around $700 million. As part of its strategy to exit non-core areas, the infrastructure major is also likely to sell stakes in L&T EWAC Alloys.
The road business will also be spun off. "Once we did the restructuring of road business under L&T IDPL. Today I am struggling because of seven bad assets of the total 17 roads. Nobody will pay me the price. So we will restructure and keep with ourselves. We will spin it off in the market when we have 10-15 healthy assets," says Naik.
"This is part of a five-year plan. The idea is to simplify the structure and bring more accountability to business units and convert them into subsidiaries for public listing. L&T will continue to hold majority share in all subsidiaries and will be a kind of holding company," Naik explains.
Not many people understand L&T today. They think L&T makes tall buildings and bridges. "That is only one part of our activity. We make 'Super Hi-tech', not even 'hi-tech', plants and products. For example, in the International Thermonuclear Experimental Reactor (ITER) project of 10 chosen nations coming up in France, L&T represents India," says Naik.
Arvind Mahajan, head of energy and infrastructure at KPMG in India says, "It is important for L&T to research in advanced technology to counter the threat of Japanese, French and Chinese in the Indian market." Naik's goal is not too different: "I will de-emphasise all low-technology projects and work on hi-tech in every business. The target is to generate a revenue of Rs 1,50,000 crore by 2020, but only from tech intensive projects. We will not bid for small and low-tech projects." Defence is targeted to be Rs 10,000 crore a year, nuclear Rs 3000-4000 crore, IT and technology engineering services Rs 8000 crore and Smart World Rs 7,000 crore. This excludes potential revenue of Rs 10,000 crore from businesses such as roads and construction.
L&T's international business will be restricted primarily to Middle-East, Africa and South-East Asia. Exports, IT and technology services will be targeted globally. Ideally, the revenue mix will be 30 per cent global and 70 per cent domestic in future. Besides, Subrahmanyan also needs to find answers to some of L&T's ticklish problems.
The Pain Ahead
In the previous financial year, L&T's order inflow fell 12 per cent to Rs 1,36,900 crore. In the seven months until February 12, L&T's market value fell by Rs 80,000 crore, or 43.7 per cent. In comparison, the BSE Sensex fell 17 per cent. It has since improved by 41 per cent to Rs 1,38,598 crore on June 10, but concerns remain.
Considering an order book of Rs 2,50,000 crore (as on March 2016), the fall in order inflow is a long-term worry since the existing backlog is sufficient for just two-three years. But R. Shankar Raman, CFO, believes an economic revival will take time. "Private sector and industrial capital expenditure takes time. Execution conditions remain challenging because of the limited projects. Banking system is stretched in corporate lending," he adds.
Subrahmanyan's other task is to revive L&T's flagging businesses. Between 2003 and 2009, when L&T was booming on all parameters, it invested in shipyard, ports, nuclear forging and power. Public sector shipyards were inefficient and the government was talking about privatising defence, which in turn was to trigger orders at shipyards. In 2007, L&T took the decision to build a shipyard at Kattupalli. It anticipated the government would take three to four years before giving defence ship building orders to the private sector. The shipyard got completed by 2011. The adjoining port had been developed to support the shipyard. But the orders are nowhere in sight.
After the UPA government signed the civil nuclear agreement (123 agreement) with the US, L&T sniffed an opportunity in nuclear manufacturing. It constructed nuclear forging facility at Hazira in 2012. Similarly, the construction giant bet heavily in power business during the boom time, forming a joint venture with Mitsubishi Hitachi Power Systems (MHPS) to manufacture supercritical boilers and turbines. In addition, it built a 1,400-megawatt (MW) reference power plant at Nabha with supercritical technology. Despite an investment of Rs 25,000 crore over five years, most of these projects remain heavily underutilised. L&T's capital-light balance sheet was overburdened due to these large commitments.
Its core engineering, procurement and construction (EPC) business needed minimal working capital instead of equity and debt. Since the assets on books were low, the company's return on capital employed (RoCE) was 27-30 per cent in 2007-09. After the commissioning of large projects, the RoCE fell to 12 per cent.
L&T management chalked out a plan for the next five years with the theme "profitable growth", under Lakshya 2021. "We think the worst is over. The company expects orders for its shipyard from the private sector," says Shankar Raman. In a nutshell, Lakshya should enhance profitability by releasing locked capital, turning around struggling assets, making the core business working capital efficient, optimising cost and shedding non-core assets.
There are also concerns around the Middle-East businesses (15-20 per cent of revenue) as the fall in crude price has shaken the hydrocarbon business in ME and its impact has spread across other sectors in the region.
Naik says L&T's margins have always been around 11.5-12 per cent, but are down to 10 per cent today. "The fall in margins is mainly because of bleeding hydrocarbon projects in the Middle-East, the loss making nuclear forging shop and the shipyards. I think these problems will be over and we will have very robust profits by 2018/19," he adds.
The target is to increase the RoCE to the pre-2010 level of around 30 per cent, says Raman. "Even if we achieve 20 per cent from the present 12 per cent, it will substantially increase the profitability. By 2018-19, we expect an economic boom and it will help us reach the target."
The big bets are on three new areas - defence, nuclear and aerospace. Overall, around Rs 1 lakh crore order intake is likely in three years between defence, nuclear, defence electronics and aerospace, says Naik. L&T has also pinned hopes on L&T Smart, its smart city initiative, also being managed by Subrahmanyan. L&T Smart is a natural diversification as the company has many verticals executing projects in optical fibre and communication, traffic and security management and railways.
Finally, Subrahmanyan has to contend with L&T's perennial talent shortage. L&T Infotech had been without a CEO for one year after joint CEOs Vivek Chopra and Mukesh Aghi quit in October 2014. Finally in 2015, the company appointed Infosys veteran Sanjay Jalona as the CEO and MD. At L&T Realty, former Emaar MGF CEO Shrikant Joshi became the head. From Mahindra Satyam, former DRDO scientist Keshab Panda joined as CEO of L&T Technology Services. Hydrocarbon took seven years to get a head. In power, it has internally transferred Derek Michael Shaw from heavy engineering. Shailendra Roy will retire in 2020. Naik has to find a boss for heavy engineering - which includes nuclear, defence and aerospace - most probably from abroad. Ship building and industrial machinery verticals will need heads in the near term. Finance and accounts need to be strengthened. Hasit Joshipura, who reports to Naik, has many functions, including corporate strategy, mergers and Acquisitions, legal and corporate brand management. His work load will be reduced.
"Soon, I am meeting about 20 youngsters to see whether anyone has the potential to fill in the vacant positions. It is a tremendous amount of task for creating management teams of high class for 82 businesses," says Naik.
Naik grooms nearly 25 executive assistants, who shadow him through meetings and travel. Similarly, Subrahmanyan grooms about 10 executives. Yet, several top-level vacancies remain vacant.
Clearly, L&T needs many more than those. And fast.