Mindtree: Tryst with the Corporate Control Market

Prologue

In the middle of March 2019, Larsen & Toubro Ltd (L&T) announced its acquisition of 20.32% shares of Mindtree Ltd (ML) from V. G. Siddhartha, the largest shareholder of ML. L&T also announced its intention to acquire another 46% shares of the company through market operations and through an open offer. ¹ Business press in India described this as the first hostile corporate raid ² in the information technology (IT) sector while L&T, through its CEO and managing director, took pains to explain that L&T was not a corporate raider. He argued that L&T ‘was a professionally run, entrepreneurial company seeking to work with another like-minded entity to realize bigger aspirations in technology services’. ³

Co-founders of ML, who were still with ML, perceived the bid as hostile and aimed at destroying the unique identity and culture assiduously nurtured by them. They could not prevent the takeover; by the end of June 2019, L&T controlled more than 60% shares ML. Was the capital market cruel and unjust to the co-founders of ML? Could they have averted the takeover? Did this episode offer any learning to the large number of founders of start-ups and new ventures?

Mindtree Ltd: Genesis

In August 1999,10 software professionals, under the leadership of Ashok Soota, former vice chairman of Wipro IT services business, founded Mindtree Consulting Private Ltd based at Bangalore, India. They came from leading infotech companies such as Wipro Ltd, Cambridge Technology Partners Inc, Lucent Technologies and so on. ML was formally launched on 19 August 1999. V. G. Siddhartha, a close friend of Ashok Soota, came in as first investor in the company. Siddhartha together with Walden Software had invested $8 million while the founders had mobilized $1.4 million. In the first year, Mindtree recorded a turnover of $100 million, while Infosys, a leading infotech company of India, recorded a turnover of $120 million. ⁴

The technology services offered by the company included e-commerce, mobile applications, cloud computing, digital transformation, data analytics, enterprise application integration, enterprise resource planning and so on. The company was actively funded by venture capitalists like Walden International, Sivan Enterprises and later, in 2001, by Capital Group and Franklin Templeton. In February 2007, the initial public offering (IPO) of shares of the company was oversubscribed by more than 100 times. In 2012, the company was renamed Mindtree Limited and had revamped its logo and identity. The company pursued a path of organic and inorganic growth by acquiring a number of companies across the world and venturing into new geographies and businesses. Over the years, the company had established a number of subsidiaries in other countries to pursue its operations.

The team of 10 co-founders, who have been groomed in some of the best IT companies of India and abroad, took special care to develop a positive work culture and ecosystem in Mindtree. The major challenges that ML faced in the initial decade-and-a-half were (a) the dot-com-boom-and-burst at the dawn of the millennium, (b) the crash of the global markets in the post-9/11 scenario (the IPO of Mindtree hit the capital market only few days before the 9/11 event) and (c) the slow-down of the global economy in the post-sub-prime crisis. In 2008, Mindtree planned to launch mobile handsets but the initiative failed miserably. This had resulted in some heartburn internally; Ashok Soota, who had spearheaded this initiative, took it to heart and decided to quit the company. ⁵

Transition from an Independent Company to a Member of the L&T Group

G V Siddhartha and Mindtree Ltd: G. V. Siddhartha, the first investor into the company, had played a significant role in the growth of the company. It was Siddhartha who prompted and encouraged Ashok Soota to float a new venture in the IT space. Siddhartha had his own business interests, which included coffee plantations, Café Coffee Day and a finance company, Global Technology Ventures. ⁶ In the early days, the co-founders held 75% shares of the company while Siddhartha and Walden Capital held the rest 25%. Siddhartha was much more than just an investor in the company. He shared the agony and ecstasy of the promoters right through the growth phase of the company. He had been a non-executive director of the company from inception. Siddhartha was instrumental in each of the fund-raising transactions of the company. When Ashok Soota wanted to leave ML, the first option of acquiring his shares (11.6%) were offered to other co-founders. When they declined, Siddhartha acquired those shares. Similarly, shares of Walden Capital, on its exit, were also bought by Siddhartha and associates. ⁷ These acquisitions made him the largest shareholder of the company with 20.32% holding. He was a pillar of strength in all financial matters, to the co-founders who were essentially technocrats. In fact, he was a white knight to the founders of the company, holding his shares, since 1999, absolutely loyal to the interests of the co-founders, helping the company in its fund-raising efforts, buying out the co-founders on their exit, from time to time, and not interfering in the day-to-day operations of the company.

Crisis at the House of Siddhartha: In 2017, Siddhartha’s businesses were facing severe financial crisis. He had significant investment in IL&FS, the leading infrastructure finance company of India. This company had started defaulting its commitments due to high level of non-performing assets within its portfolio. In 2018, IL&FS reached a stage of collapse. This situation created financial crisis to Siddhartha and his companies as investors. ⁸ Further, his own outfit, Café Coffee Day, was not doing well financially. To meet payment commitments, Siddhartha had availed loans of ₹30 billion from banks against the pledge of shares. When the banks demanded repayment, Siddhartha had no option except selling his shares. He first approached the co-founders/promoters of ML so that their control of ML was not compromised. Since they were not comfortable to acquire, Siddhartha along with them started searching for a buyer who would be agreeable to the co-founders managing the company. ⁹ They could identify one private equity investor, and the price of acquisition was negotiated at ₹975 per share.

Before the shares could be transferred to the acquirer’s name, they needed to be un-pledged; the un-pledging fee was demanded up-front. Alternatively, the shares would stay with the bank while transactions were under way. The acquirer was not comfortable with this process. Siddhartha and the co-founders could not help resolve the situation and the deal failed to take place. Since the pressure of financial crisis was intense on Siddhartha, he could not help accepting first willing buyer he met. He approached L&T and there was immediate response to acquire the entire lot at a price of ₹980 per share. What he could not ensure was whether L&T was acceptable to the co-founders or not.

Response of Larsen & Toubro Ltd: L&T’s response was positive and prompt. It wanted to control the company through a larger stake. But it did not want to disrupt the harmonious working of the company by a rapid merger of ML with one of the group companies. L&T announced its acquisition plan with the following features: ¹⁰

Acquire holdings (20.32% of ML) of G. V. Siddhartha at ₹980 per share.

Response of Mindtree Management: Of the 11 players of the initial Mindtree team—10 co-founders and G. V. Siddhartha—only four were present in January 2019. These were Krishnakumar Natarajan (executive chairman since April 2018), Rostov Ravanan (CEO & MD), NS Parthasarathy (director) and Subroto Bagchi (independent director). G. V. Siddhartha had dissociated from the board in August 2018 in view of his exit plans. Subroto Bagchi had stepped down as executive chairman of ML on 31 January 2016 to become full-time chairman of Orissa Skill Development Authority. He continued his association with ML as an independent director.

They were not inclined to let go ML from their control. They had not expected Siddhartha’s independent action; probably they were not aware of Siddhartha’s financial position. ¹¹ Subroto Bagchi rushed ¹² to the defence of ML; he shot an emotional letter to every mindtreemind (employee) about the uniqueness of the experiment called Mindtree and the need to defend its independent existence.

The counter-strategy the co-founders could come up with had two major elements ¹³ :

Share buyback scheme: This could reduce the equity stock of the company and thus enhance the percentage holding of the promoters/co-founders. Company Law permitted use of 10% of free reserves for share buyback. With ₹25 billion as free reserves on 31 March 2018, ML could use ₹2.5 billion for share buyback. At a price of around ₹980, ML could extinguish near about 2.55 million shares from the total outstanding shares of 165 million. This would only make a marginal increase in the percentage of promoter holding. Besides, L&T with 20.32% shares acquired from Siddhartha and additional shares being purchased every day from the market had already become the largest shareholder of ML. How could the co-founders (13.32% holding) get a resolution for share buyback passed without the concurrence of the largest shareholder (L&T)? This strategy was just not workable.

In a press conference held on 18 March 2019 at Bangalore, ¹⁴ the co-founders said that ML was designed and created with a unique culture and the proposed acquisition would only destroy the culture of the company. They did not see any synergy in the proposal and believed the acquisition would lead to an act of value destruction. They wanted all stakeholders to reject the proposal. They also expected the government would support their case.

The Last Tango: L&T, immediately after acquiring Siddhartha’s holding in mid-March 2019, went ahead with its market operations. By the last week of April, its shareholding in ML had already crossed 26% and it had obtained green signal from the Competition Commission of India for its acquisition proposal. The open offer from L&T to existing shareholders of ML was scheduled to be rolled out between 14 May and 27 May 2019. L&T, as the largest shareholder of ML, requested the management ¹⁵ of ML to convene a meeting of the shareholders of the company to discuss matters of ‘corporate governance and inclusion’. This implied a formal announcement of L&T’s entry into ML and its demand for positions on the board.

The open offer attracted almost 33% of the shares for transfer. On completion of all formalities, L&T held more than 60% shares. Krishnakumar Natarajan resigned from the position of executive chairman; Rostov Ravanan relinquished the position of CEO and MD. L&T nominated ¹⁶ A. M. Naik, its executive chairman, as the non-executive chairman of ML. S. N. Subramanian, MD of L&T who spearheaded the acquisition process, was nominated as the non-executive vice chairman of ML. A. M. Naik, on assuming the new position at ML, assured the employees of ML a new CEO in a short time. In a letter addressed to the employees of ML, he stated ¹⁷ :

Over the past decade, we have closely followed with a lot of respect and admiration the organization’s rise from an innovative start-up to a digital powerhouse…. I see this as coming together of two great institutions with shared passion for delivering extraordinary value to clients, employees, shareholders…. All this spells growth. It means that you are now artists with a much larger canvas before you, more avenues leading up and more opportunities to do what you do the best…. We believe people are the prime movers and real assets of an organization .… And look where L&T’s people have taken the company – deep into the ocean and up in the space….

On 5 August 2019, Debasish Chatterjee, who was in the leadership team of Cognizant, with wealth of experience in India and abroad, joined ML as CEO and MD to lead the team into the future for the benefit of all stakeholders.

Alchemy of Acquisition: Implications

A merger is considered successful when the combined entity, due to synergy effect, emerges larger than the sum of the individual entities. In the present case, there was no merger per se; the entities continued to exist independently with individual brands and operations. Only the management control of the entities had converged. In understanding the merger, analysis of the following issues would be helpful:

Did the convergence make any sense to the two entities? Did it make any sense to the shareholders at large? Did it pave the way for rapid growth of both the entities?

Going Public and the Consequent Transformations

Going public or becoming a public limited entity is a major milestone in the life of an enterprise. The process of going public envisages the transformation of the entity, from the closely-held stage at its inception, into a stage where its ownership is being shared with a large number of investors hitherto unknown to the founders of the entity. From this stage onwards, the directors of the entity have to manage and lead the entity on behalf of the investors, who are the real owners of the entity, in trust to their aspirations. By and large, a closely-held entity would choose to become public, when it has grown fairly big or large in terms of the size of investments, volume of operations and diversity of the investors. By this time, it is expected that the management of the entity would have acquired certain threshold levels of maturity and sophistication; similarly, the governance of the entity would demand certain threshold levels of transparency, disclosure, equity and justice. Since justice and fair play to all stakeholders are of paramount importance, a whole range of regulations, including a set of regulators for surveillance and course corrections, would invariably be in existence in any healthy capital market system.

Before ML chose to go public in 2007, 75% of its shares were held by the co-founders and the rest 25% were held by their financiers (G. V. Siddhartha, Walden Capital etc.). In the next 11 years, seven of the co-founders (Ashok Soota, TGC Prasad, Amit Agarwal, Eric Mann, Joseph King, S. Janakiraman and Subroto Bagchi) chose to leave ML, at different points of time, for their own reasons. In early 2018, the remaining three co-founders held 13.32%, G. V. Siddhartha and associates 20.32%, employees 16.67% (thanks to the employee stock option plan the company had implemented early!), and the rest were widely held among the public (see details at Exhibit 2). With the support of Siddhartha and the employees, the co-founders controlled little more than 50% of the shareholding. ²³

The co-founders had not identified themselves formally as an investor group. They had not tried to increase their individual holdings from the market. They were too naïve to buy shares from other co-founders when they exited one by one. On each such occasion, it was G. V. Siddhartha who bought the shares. They relied on G. V. Siddhartha and expected him to be there forever. They had not visualized any corporate control strategy; this paved the way for their eventual exit. The capital market has become increasingly competitive; it rewards only those who are vigilant and competent.

Changing Profiles: Leadership Role vs Leader Aspirations

The role of the leader of a business entity is bound to be different at different stages of evolution of the entity. At the founding stage, all the functions of the business are bundled into the singular role of the founder. At later stages, different functions emerge in varying levels of criticality, and the leader can afford to delegate at least some of these. Once the entity has blossomed into a large publicly held corporation, continued success depended on sustaining satisfaction of the investors, customers, employees, input suppliers and other stakeholders.

With time, the leader also evolves and would have own preferences about the role he/she would like to play. Some of the co-founders of the entity prefer to remain creative and innovative professionals. Once the entity has achieved certain critical mass, they would no more be comfortable with the entity. They would unhook themselves from the entity and chase new ventures. Some co-founders prefer to nurture the entity right through their personal lives; these co-founders would become managers and directors and would retire eventually. Many other co-founders would like to own their ventures and possibly convert them into a group of businesses. Each founder need to choose his long-term goal well in advance, create appropriate strategy and work towards that.

Epilogue

In the final analysis, was it just another case of a large fish swallowing the smaller one or did it signify something more than that?