Investors of Mindtree have been offered an exit through an open offer at Rs 980 by L&T, which is the same price it bought shares from V.G. Siddhartha of Coffee Day Enterprises earlier this March. According to reports, the open offer has already been subscribed, but there is every chance that your shares may be acquired on a proportionate basis when you tender them.

L&T has already accumulated adequate stake in Mindtree to make this open offer a certain success. An independent directors’ committee of Mindtree’s board has already said the Rs 980 per share offer by L&T is a fair price for the open offer.

The offer price discounts Mindtree’s trailing earnings by 21.32 times. This multiple is placed between the valuations of L&T’s two software services subsidiaries, L&T Infotech and L&T Technology Services.

Investors in Mindtree are better off tendering their shares in this offer. While Mindtree’s operating margins can improve post-merger, lack of clarity on the merger plan between L&T’s software subsidiaries and Mindtree, the possibility of increase in attrition impacting margins, and uncertain business growth due to a change in the top management are immediate concerns.

The concerns

L&T has not articulated the manner in which the eventual merger of Mindtree with L&T will unfold. According to reports, L&T already owns nearly 48 per cent stake in Mindtree. It’s a matter of when and not if Mindtree will get merged into L&T’s software services companies. There is currently no indication about the contours of the merger, to determine if it will be favourable to the remaining shareholders or not.

Mindtree managed to surpass $1 billion in revenue in FY19, but tempered its growth expectations for 2019-20 with the management guiding for a “lower teens” constant currency growth in revenue. This is far lower than the18.3 per cent constant currency growth in revenue witnessed in 2018-19. The management, however, expects a 100-120 bps increase in EBITDA margins in FY20, from 15.2 per cent in 2018-19.

However, the fourth quarter of FY19 saw one of the lowest client additions of 15 in the last 16 quarters and deal bookings also slowed to a five-quarter low in the period.

This guidance seems to have been factored in the current market price. The ownership change could also result in the change in management of the company. If client relationships change and attrition levels rise, some of these guided numbers could abruptly change.

Also the vehemence with which some of the founders claimed that L&T’s acquisition will lead to value destruction can’t be dismissed as emotional attachment to a company they founded.

L&T Infotech and L&T Technology Services financial metrics are superior to Mindtree. These companies grew their revenue 19.1 per cent and 18 per cent, respectively, in US dollar terms in FY19. Their EBIT margins stood at 16.05 per cent and 15.11, respectively as against the EBIT of 12.82 per cent of Mindtree.

But given the fact that this is a hostile takeover, L&T might find it difficult to improve the growth and margins of Mindtree, in the immediate future.

Risk of key clients and talent exit

With reports that L&T wants a new management team in place, after the company nominating three members on Mindtree’s board, there is a possibility that senior management might follow them through the exit door. L&T will have to get the ball rolling immediately after it hires a new management to retain key clients who had strong relationships with the existing Mindtree management. If some clients walk out the door, any synergy expected from the deal would be lost.

L&T is trying to build a full-fledged software services player by acquiring Mindtree for its expertise, but this might be easier said than done.