Event update: Larsen & Toubro (Outperformer) - Mindtree acquisition a long-term bet
Event
L&T signs agreement to acquire 20.32% stake in Mindtree; seeks to acquire additional 46% through open offer and market purchases
Details
- Acquisition details: L&T is to acquire 20.32% stake in Mindtree from Mr. V G Siddhartha (financial investor) at Rs980/share. L&T has also initiated the purchase of additional 15% stake from the market for up to Rs980/share and given an open offer to Mindtree shareholders for 31% stake at Rs980/share. The above share purchases amount to a total consideration of Rs107bn and are subject to requisite regulatory approvals in India and abroad (likely to take 45-60 days).
- Why is L&T and not L&T Infotech (LTI) acquiring Mindtree?: We believe L&T is 1) avoiding to stretch its finances and integration issues for LTI 2) looking to effectively deploy its cash and equivalents (Rs127bn on a standalone basis as of Sep 2018), given the uncertainty over approval of its Rs90bn share buyback plan (already declined once).
- Rationale and the way forward: Rationale: 1) Increase the share of services revenue (from ~20% currently to ~1/3rd) as a hedge against cyclicality of the projects businesses 2) LTI and Mindtree’s skill sets are complimentary and have minimal overlap 3) Both L&T/LTI and Mindtree are professionally managed, having good cultural fit 4) Acquire significant scale on a combined basis over the medium to long term. Way forward: 1) Mindtree and LTI will continue to operate as independently listed entities (at least for next 5 years) 2) Retain talent and ensure continuity in both companies with L&T playing the role of a growth enabler 3) Explore a merger to exploit synergies, once both entities acquire significant scale.
Our View
L&T’s proposed acquisition of a majority stake in Mindtree appears to be substantially triggered by the need to deploy its surplus cash in a tax-efficient manner, while also building scale and capabilities in its IT businesses. While the acquisition rationale is strong, the same is likely to be EPS/ROE-neutral in the near term (~5.5% yield on FY20E EPS; in line with post-tax yield on cash surplus) with RoE benefits to accrue over 3-5 years. We maintain Outperformer on L&T, given its robust order backlog and strong 15% earnings CAGR over FY18-21E with a target price of Rs1,518.
Larsen and Toubro is engaged in the following business segments: Engineering & Construction; Electrical & Electronics; Machinery & Industrial Products; and Other. Engineering and construction segment comprises execution of construction projects in civil, mechanical and electrical engineering. Electrical and electronics segment comprises the manufacture and sale of switchgear, petroleum dispensing pumps, and medical equipment. Machinery and industrial products segment comprises the manufacture and sale of industrial machinery and equipment. Other segment includes property and software development, generation of power for consumption by Haldia Petrochemicals Limited, and financial services.
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