L&T expects Mindtree investment to generate above-average returns

The money managers of construction major L&T have changed their capital allocation policy by expecting the Mindtree ‘acquisition’ to generate better returns than the average 5 per cent being generated from the Rs 16,000 crore cash in its books. 

It’s the effective cash management by L&T that prompted its top shareholders to give their consent for the “hostile” acquisition plan, say company insiders.

According to the current plan, L&T will end up investing Rs 10,700 crore in buying 66 per cent stake in Mindtree.  

R Shankar Raman, CFO and member of L&T board, said one of the top questions raised during the company’s meetings with investors was the kind of value the Mindtree investment is expected to add. 

“The investment, currently sitting in the balance sheet today as cash, is earning 5 per cent return. So, the least that we will get is 5 per cent and the only question was whether this five per cent can become 10 per cent, 15 per cent or 20 per cent. So, the focus is on how to grow this investment rather than defend the investment,” said Raman.

He said L&T will be able to recoup its Mindtree investment in the next four quarters as the company is earning Rs 1,500 crore cash every quarter, net of debt servicing. “From L&T shareholders’ point of view, committing Rs 9,000 crore in Mindtree is not a big deal. They know in four quarters, I will recoup this cash back. We need to have a much larger vision about investment in growing businesses because this is a cash-generating business that we run and we don’t have debt to repay. In today’s world, we will possibly be the only company that doesn’t have any debt to repay,” Raman said.

Analysts said due to the Mindtree acquisition plan, L&T’s plan to buy back shares worth Rs 9,000 crore would be further pushed back. 

“The buyback plan initially got deferred as the Securities and Exchange Board of India (Sebi) guidelines required the company to have a debt-to-equity ratio within the permissible limit of 2:1 at the consolidated level. For L&T, this would be higher, given the higher debt on account of the non-banking financial service business,” said analysts at Motilal Oswal.

“Now, with free cash being utilised for acquisition purposes, the buyback plan of the company would further be pushed back till additional cash is generated from business and Sebi guidelines are amended to consider debt-to-equity ratio on a standalone basis,” said the analysts.

The Mindtree acquisition, however, raises a few questions on the capital allocation policy, especially given that L&T has been on track to meet its return on equity (RoE) guidance of 18 per cent by fiscal 2021 and divesting its non-core assets.

“The concerns may rise in case the cost of acquisition increases in due course of time. Ideally, L&T shareholders would have preferred buyback as the best utilisation of the cash balance. Even the management had the same intention until it was rejected by Sebi,” wrote research analysts Nilesh Bhaiya and Amit Shah of Motilal Oswal Financial Services in a note dated March 19.

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