Larsen & Toubro Ltd’s (L&T's) reported plan to buy a large stake in Mindtree has led to a fall in the value of its software services arm
L&T Infotech investors’ worries aren’t limited to those of a typical M&A transaction
A mergers and acquisitions (M&A) transaction typically boosts the shares of the target company and weighs down the shares of the acquirer. It’s no different in the case of mid-sized IT company Mindtree Ltd, and one of its potential acquirers.
Larsen & Toubro Ltd’s (L&T) reported plan to buy a large stake in Mindtree has led to a fall in the value of its software services arm, Larsen and Toubro Infotech Ltd. The IT subsidiary’s valuation has fallen nearly 11% since mid-January, on fears that a possible combination can be a drag on its performance. Reports of L&T’s interest had emerged first in mid-January. Mindtree shares, meanwhile, have risen about 7% in the same period, adding to the gains since October last year.
L&T Infotech investors’ worries aren’t limited to those of a typical M&A transaction. Reports suggest L&T is attempting a hostile takeover, since Mindtree’s promoters are trying their best to stall the deal. On Friday, Mindtree said its board will consider a buyback of shares, a move that is known to be used to thwart hostile takeover attempts.
A hostile takeover in an industry such as software services, where people are the biggest assets, can backfire. “We are not aware of any precedent where there has been a hostile takeover in the IT services business. This is primarily because this is a business of relationships and execution by people," analysts at Investec Capital Services (India) Pvt. Ltd said in a note to clients.
Moreover, the success rates in the case of acquisitions that are greater than 50% of the acquirer’s size is likely very low, they add. Mindtree’s annualised Q3FY19 revenues stood at a little over a billion dollars, or 72.5% the size of L&T Infotech.
Even if Mindtree’s promoters somehow agree to strike a deal, the cultural differences between the two companies can create hurdles going ahead, warn some analysts. “L&T Infotech comes from a group that is predominantly in the manufacturing business, while Mindtree is a services firm from the ground up; shall the twain ever meet?" said an analyst who preferred anonymity.
If, however, they do find a meeting point, there will be benefits of scale. The combined entity’s annual revenues will be nearly $2.4 billion. Dependence on large clients will reduce and services offerings will expand. And as the chart alongside shows, the combine’s banking, financial services and insurance vertical will reach a size of $870 million, not far from the crucial $1 billion mark that helps open doors to large customers. What’s more, cost synergies from sales and general administration can result in meaningful savings as well, say analysts at Investec Capital.