Bole Toh Take Over

Is it fun to be hostile?

Jun 08, 2022

Motabhai’s midweek madness continues, there is a lot we need to talk about and the weeklies just dont cut it, so I guess I’m back.

Very recently L&T Technologies (NSE: LTTS) and Mindtree (NSE: MINDTREE) announced a merger to become India’s 6th largest Technology Service Providers. Now, the parent company of L&T Technologies, L&T Inc had completed the hostile take over of Mindtree Tech in 2019. Now L&T is a curious case because the company itself was subject to a hostile takeover bid by Manu Chabbria in the late 1980s. We’re going to use this company to understand hostile takeovers as a whole.

What is a Hostile Takeover?

After an overall appraisal of the transaction, friendly takeovers, which occur by mutual consent of the target and acquiring company, have been fairly prevalent in the Indian M&A sector. In contrast to such takeovers, hostile takeovers involve disagreement on the part of the target company's management, i.e., the target company does not want to be bought. Despite this dispute, the purchasing business makes the acquisition hostile by continuing to pursue it. A hostile takeover is motivated by a variety of factors, including the desire to eliminate competitors, an undervalued target, and so on.

In the above scenario, L&T was faced with multiple issues in 2019. It's worth noting that Mindtree was not L&T's first choice. Rather, the corporation desired to buyback outstanding stock from the market. The Securities and Exchanges Bureau of India thwarted this $1.5 billion deal . SEBI protested because L&T's debt-to-equity ratio would have breached 2:1 after the buyback. This is in violation of SEBI's compliance guidelines.

L&T didn't have a lot of other options, either. Excess dividends had already been paid by the corporation. The dividend paid in 2016 was a mind-boggling 33 percent of the company's annual profit. The issue with increasing payouts is that it creates future expectations. As a result, if dividends are raised, they cannot be cut in the future without causing a market reaction. This is why L&T decided against paying dividends.

In addition, L&T was under pressure to boost its return on equity. In the last decade, the company's return has dropped from 24 percent to as low as 9%. At the time, L&T's ROE had settled at a reasonable 15 percent. The shareholders, on the other hand, were ravenous for more. This is why L&T was forced to sell non-core assets and reinvest the money in high-margin industries such as software.

Now, coming to L&T’s hostile take over, There were three efforts to buy Larsen & Toubro between 1987 and 2004. Manohar (or Manu) Chhabria, a Dubai-based billionaire, won a protracted fight to control Shaw Wallace in 1987. Following that, he focused on L&T. The company lacked identified promoters, making it a tempting acquisition target. Manu began buying L&T shares on the open market, and by July 1988, his investment had grown to 1.5 percent of the company's equity. This fueled market speculation that India's largest engineering firm was poised to be acquired. To avoid a takeover, L&T Chairman M.N. Desai is said to have enlisted the help of Dhirubhai Ambani, Chairman of Reliance Industries Ltd. (RIL). Here Reliance was the “White Knight”.

How to Thwart a Hostile Takeover?

Companies employ a host of methods to thwart hostile takeover bids. These attempts are all used to ensure that the company doesn’t change hands without the permission of the shareholders and the promoters.

Companies can employe a buyback of shares where they buy shares back from retail and institutional investors to increase promoter holdings to thwart acquisition by the hotile entity by having a larger stake than being bid for.

We read about a “White Knight” above, a white knight is an individual or corporation who purchases a target firm when it is about to be taken over by a black knight, i.e., a hostile or unfriendly acquirer, thereby rescuing the target company from a hostile takeover. When the target company is taken over by the white knight, there is no change of management, unlike in a hostile takeover.

During the hostile takeover in Pac-Man, the target firm tries to preserve itself by reversing roles, i.e., the target company makes a counteroffer to the acquirer and begins purchasing shares of the acquirer, threatening to purchase the raider themselves. As a result, the raider becomes preoccupied with saving itself, forcing them to reach an agreement.

In a Shark repellent plan special amendments to a company's legal charter can be made that only take effect if a takeover attempt is made. These changes are being made to ensure that the board of directors does not lose control of the corporation.

In the golden parachute plan, considerable benefits are provided to executive staff in the event that the company is acquired by another company and their job is terminated as a result. Golden parachute is the name of the defensive strategy because it allows a soft landing for people in particular positions within the target organisation. Although this raises the acquisition company's costs, the major goal is to preserve the interests of the employees who have worked hard to develop the company.

The Crown Jewel strategy involves the target making itself less appealing to the purchaser by selling off its most valuable asset, which may have initially attracted the acquirer. The target firm might use this technique in conjunction with a white knight, in which the target company would demerge its prized asset and sell it to a white knight, who would then buy it back at a fixed price later.

There is one more strategy known as the Poison Pill, that has been used multiple times by companies in the United States of America to thwart such bids. These defences are more frequently known as shareholder rights schemes. This defence is divisive, and several jurisdictions have restricted its use. To carry out a poison pill, the targeted firm dilutes its shares to the point that a hostile bidder can't secure a controlling share without incurring significant costs.

In the above case, during the Mindtree takeover, Mindtree employed both the Buyback and the White Knight defences but failed. To avert the takeover, the management issued a notice for consideration of a share buyback in accordance with SEBI Listing Obligations and Disclosure Requirements (LODR) Regulations, 2015, Reg. 29(1) (b) and 29(2). The board, however, decided not to go ahead with the proposal to buy back its shares since it would not have had the desired effect of obtaining a large enough holding to stave off the hostile takeover. Mindtree's promoters approached a number of private equity (PE) firms, including KKR & Co. Inc., Chrys Capital, and others. However, because the PE firms sought a majority position in the company, none of them consented to be the white knight, and Mindtree's white knight defence failed.

In the case of thwarting the takeover by Manu Chhabria, L&T approached RIL to be the “White Knight” in their case, and Reliance agreed by buying almost a 18.5% stake in the company from the open market at a cost of Rs 190 crore. Given the investment, he requested and received the leadership of the L&T board of directors. Mukesh and Anil, his sons, had also joined the board. However, when Dhirubhai was elected chairman, his actual motives were revealed, and N M Desai was fired from his own firm. Because L&T was a cash-rich company, he used a line of credit to purchase large blocks of RIL stock for L&T. At the time, L&T was working on Reliance Petrochemicals' 30-million-tonne naphtha-cracker refinery complex in Hazira. After the Hazira Project was completed, Dhirubhai had intentions to transfer all of those technologies to L&T.

However, India's central government underwent four changes between 1989 and 1991. Given that the government of India owned over a third of L&T through prominent financial institutions like as GIC, UTI, and LIC, as well as pressure from opposition parties, there was growing desire that the firm be kept autonomous and competently managed. Its management should not be handed over to another family-owned corporation. Dhirubhai surrendered, but he remained a passive investor, owning roughly 10% of the L&T stock. Therefore in the case of a hostile takeover by RIL on L&T, it was the government through its majority shareholding via its firms like LIC, thwarted Dhirubai’s bid to takeover L&T.

Hostile Takeovers In Indian Law

Post the multiple attempts of hostile takeovers in the late 80s to early 2000s, the Indian Government enacted the Takeover code of 2011. According to news reports, the Takeover Code of 2011 has made hostile takeovers more difficult for raiders. Voluntary open offers by outsiders have become nearly impossible due to Regulation 6 of the Takeover Code of 2011, which allows only persons with a minimum 25% stake in the organization to make voluntary open bids. Furthermore, rules such as not acquiring shares in the target firm for 52 weeks before, during, and 6 months after making a voluntary open offer make a traditional hostile takeover practically difficult in India.

Now in our case, L&T only had a stake which was much smaller than 25% in Mindtree, how did it go ahead then?

V. G. Siddhartha, a non-executive director of Mindtree and the founder-promoter of Coffee Day Enterprises (CDE), owned 20% of Mindtree shares directly and through his companies, while the promoters of the target company had only 13.32 %. Because Siddhartha and his company were in debt and wanted to liquidate their Mindtree assets as soon as possible, Siddhartha urged L&T to buy their shares. L&T's shareholding in the target company greatly exceeded that of the promoters after acquiring Siddhartha's shares in 2019 at a fee of Rs. 981/- per share. L&T then made an open offer to buy the remaining 31% of the company's stock.

A voluntary open offer could only be made by persons having 25% – 75% voting rights in the firm under Reg. 6 (1) of the SEBI Substantial Acquisition of Shares and Takeover (SAST), Regulations (2011), often known as the Takeover Code. L&T managed to acquire shares from the secondary market via open market acquisitions while the matter was being considered by SEBI, bringing its ownership to 28.9% and eventually receiving SEBI's clearance.

When an acquirer has 25% or more voting rights, they must make a public announcement of an open offer for acquiring public shareholders' shares, according to Reg. 3(1) of the Takeover Code. Because there has been a significant change in the company's control, management, and promoters, this presents public shareholders with an exit option. As a result, L&T published a public statement for an open offer of 31% of Mindtree's total voting share capital, as required by law. In a nutshell, L&T acquired around 20% of the target company's shares through direct acquisition from Siddhartha and his companies, around 9% through on-market purchase, and finally 31 percent through the open offer, bringing L&T's total shareholding to 60% and giving them control over the target company's board and management.

Glossary

ROE: The return on equity (ROE) is a financial performance indicator that is computed by dividing net income by shareholders' equity. Because shareholders' equity equals a company's assets less its debt, the return on net assets is referred to as ROE.
Private Equity Firm: Private equity is a type of alternative investment that involves money that isn't traded on a public exchange. Private equity is made up of funds and investors who invest directly in private companies or buy out public companies, which takes them off the stock market. Private equity gets its money from institutional and individual investors. This money can be used to pay for new technology, make acquisitions, increase working capital, and strengthen and solidify a balance sheet.
M&A: Mergers and acquisitions (M&A) is a broad term for the consolidation of companies or assets through different types of financial transactions, such as mergers, acquisitions, consolidations, tender offers, the purchase of assets, and management acquisitions.

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