A security guard stands outside a project office at a construction site for the Lucknow Metro developed by Lucknow Metro Rail Corp. and operated by Larsen & Toubro Ltd. in the Hazratganj area of Lucknow, Uttar Pradesh, India. (Photographer: Prashanth Vishwanathan/Bloomberg)

L&T’s Hostile Bid Is More Than Reckless Pursuit And Ego

Mindtree Ltd.’s top brass asked if Larsen & Toubro Ltd.’s Rs 10,700-crore hostile takeover bid is driven by reckless pursuit of scale or ego. It appears to be all about money.

L&T plans to buy the software services provider as it looks to put its cash hoard to better use. That’s because the market regulator rejected L&T’s bid to reward shareholders through a buyback and it's looking to boost its return on equity— measure of profitability which, according to Edelweiss Securities, has fallen from its 2003-11 highs.

The engineering group has laid out a three-step process for the potential buyout: acquire 20.3 percent from the largest Mindtree shareholder VG Siddhartha and his Coffee Day Group, pick 15 percent from the open market, and then launch an open offer for 31 percent to take control at Rs 980 apiece.

L&T has enough firepower. The company, according to R Shankar Raman, group chief financial officer, has cash of Rs 15,000-16,000 crore today.

But has L&T been putting its cash pile to best use and is an acquisition the best option? BloombergQuint looks at the numbers:

Also read: L&T To Mindtree – Your Move Next

RoE Falls

L&T’s non-fungible investments in three manufacturing plants and road developer L&T Infrastructure Development Projects Ltd. led to a sharp drop in the company’s return on equity, according to Edelweiss Securities. The RoE fell from an average of 24 percent in 2003-11 to 14 percent in 2011-2017, the brokerage said. In 2016, it had tumbled to 9 percent, prompting the company to focus on improving working capital and selling non-core assets to push up the ratio to 18 percent by 2021.

L&T monetised non-core assets worth Rs 9,000 crore in the last three years, including initial public offers of its two software services arms L&T Infotech Ltd. and L&T Technology Services Ltd. Its RoE now stands at 15 percent.

Dividend Push

For the last 12 years, L&T has been distributing cash to its shareholders every year via dividend. It made the biggest payout of Rs 18.25 a share in 2016. The company pays about 32 percent of its net profit as dividend.

Failed Buyback

To reward shareholders, the company last year said it will buy back Rs 9,000 crore worth of shares. But its plan ran into the regulator. The Securities and Exchange Board of India asked the group to reconsider the share repurchase as its consolidated debt-to-equity ratio breached the 2 percent limit.

“We tried to come out with a buyback but we were faced with disappointment,” SN Subrahmanyan, managing director and chief executive officer at L&T, said at the press conference to announce its interest in Mindtree. “But we'll continue to try.”

Acquisition The Only Option?

L&T, which already has Rs 15,000-16,000 crore, is expected to generate close to Rs 11,000 crore in free cash flows between 2018 and 2020, according to Edelweiss Securities. The company can potentially unlock an additional Rs 21,000 crore by monetising non-core businesses in the next few years, the brokerage said.

But without a buyback, options to deploy that cash are limited. “We have completed most of our capex in the EPC and construction businesses,” said Subrahmanyan, implying the cash requirement for core operations is minimal.

That leaves it with one option to meet its 2021 RoE target: acquisition of high-return businesses.

Spending Rs 3,250 crore to acquire just 20 percent in Mindtree neither would have given enough return nor would have got the blessing of the board, Subrahmanyan said, indicating that L&T considers taking control as a better option.

L&T is investing cash temporarily in treasury products. These earn post-tax 5 percent return on investment, Raman said. The potential Mindtree acquisition at the current price doesn’t dilute the current RoE, he said. “At the current price we are maintaining RoE neutral.”

Still, Motilal Oswal doesn’t consider that as the optimum use of its cash. “Though L&T will be able to expand its RoE with Mindtree, it may not be the right move in the long run,” the brokerage said. “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 its core business. This also limits the scope of a buyback going forward as the cash will be exhausted.”

Also read: What Brokerages Have To Say About L&T’s Takeover Bid For Mindtree