L&T's hostile takeover bid for Mindtree gets thumbs-down from analysts

Larsen & Toubro’s (L&T’s) hostile takeover bid for Mindtree at Rs 980 per share in an all-cash transaction has got a thumbs-down from analysts. The hostile takeover, if goes through, will be a misfit for the engineering and construction giant, at least in the short term.

On Monday, L&T entered into a deal to purchase the 20.32 per cent stake of Mindtree’s single-largest investor, V G Siddhartha, at Rs 980 per share in an all-cash transaction. L&T now plans to buy an additional 15 per cent from the market at Rs 980 per share, for a consideration of Rs 2,434 crore. 

The price offered to shareholders as part of the open offer for an additional 31 per cent and also to the Cafe Coffee Day promoter is just 1.81 per cent higher than the Monday closing price of Rs 962.50 at the BSE.

“Ideally, in case the single-largest investor, V G Siddhartha wanted to exit, Mindtree's other promoters should have bought the stake. For L&T, I think the takeover will be a mis-fit, at least in the short-run. Reports suggest that L&T will keep Mindtree as a separate company and not merge it with L&T Infotech. Even if a merger happens, it will take three - four years for the synergies to flow seamlessly. From a short-term perspective, I am not bullish on both these stocks” says A K Prabhakar, head of research at IDBI Capital.

On Tuesday, L&T slipped 1.5 per cent in intra-day deals to Rs 1358 levels on the National Stock Exchange (NSE), while Mindtree lost 1 per cent to 953 levels. The Nifty50 was trading flat at 11,460 levels.

Over the past 10 years, Mindtree’s net sales on an annualised basis have grown at a compounded rate of 25 per cent to hit Rs 5,462.8 crore in financial year 2017 – 2018 (FY18), ACE Equity data show. Net profit during the last decade grew at a compounded annual growth rate (CAGR) of 21 per cent.

As regards historical returns, Mindtree has performed in line with the Nifty IT index over the past one year and risen 23.5 per cent, as compared to 23.7 per cent in the benchmark IT index. On the other hand, L&T has gained around 8 per cent during this period, as compared to 13.6 per cent rise in the Nifty50, ACE Equity data show.

Analysts at Jefferies, too, believe the takeover will not be in line with L&T's focus on listing non-core businesses and enhancing shareholder value. 

"Being a people’s business, integration may not be easy, especially if it is a hostile takeover. The only reason we believe L&T might get involved is to keep the two entities (L&T Infotech and Mindtree) independent for now or reluctance to leverage L&T Infotech’s balance-sheet beyond 1x. We maintain that over the next 6-12 months as core fundamentals deliver, L&T should provide strong potential upside," wrote wrote Lavina Quadros and Arya Sen of Jefferies in a report. They maintain a ‘buy’ rating on L&T with a target price of Rs 1,925 – up nearly 42 per cent from the current levels. 

While the acquisition doesn’t impact the overall consolidated earnings meaningfully, Gautam Duggad, head of research at Motilal Oswal Securitiesthe feels the proportion of services business to consolidated earnings will increase for L&T.

"Return on equity (RoE) expansion on account of purchase of non-core business is not the preferred way for L&T shareholders, as it risks long term de-rating of core business. This also limits the scope of buyback going forward as the cash will be exhausted. The stock has been an underperformer over past month or so on account of overhang of above hostile acquisition. We have a 'buy' rating on L&T with target price of Rs 1,650," he wrote in a recent report.

Adding: "At 17x FY20E, and with market purchase / open offer at Rs 980/share, upside seems capped for Mindtree. We will review our 'buy' rating on the stock, after the recent run taking it closer to our target price of Rs 1,000."