LTI-Mindtree merger, high attrition risk, too early for “1+1=2”

The LTI and Mindtree merger will make a formidable IT services company but it is too early to gauge cost synergies, said Nomura in a Quick Note.

It is “too early to say if 1+1>2”, said the report about the merger.

On May 6, LTI and Mindtree announced the merger in a 73:100 share-swap deal, under which shareholders would be given 73 shares of L&T for 100 shares of Mindtree.

According to Nomura, the benefits will come mostly at the revenue level, and not much at the cost level. With minimal client overlap, costs can be cut down in the general and administrative functions but not in the sales and marketing functions.

There is also a high risk of rise in attrition, according to the report. Sanjay Jalona has already resigned from the CEO and MD post at LTI. “We believe investors should closely monitor near-term risks manifesting in the form of higher attrition and resulting growth slippages at the two entities,” said the report.

Financial incentives to retain talent in an industry that sees high attrition can weigh on the company’s margins, according to the note.

Benefits of the merger
On the benefits of the merger, the report said, “The combined entity with revenues of USD3.5bn (FY22) and EBIT of USD625mn would become the sixth-largest IT services company in India… The businesses of the two entities are highly complimentary with minimal client overlap. LTI is stronger in the ERP, analytics and platform businesses while we think Mindtree’s strengths lie in customer experience and digital capabilities. The combined entity’s bigger size is likely to help it participate in large transformation deals in the industry, though there could be a need to fill in certain white spaces (e.g., BPO, etc) through acquisitions.”

According to the management, average deal size for the merged entity could rise to $100 million from the present $25 million for each of the entities.

On the cost synergies, the report said that this could be “minimal and could take time to accrue” because there is minimal client overlap.

“LTI is stronger in the ERP, analytics and platform businesses while we think Mindtree’s strengths lie in customer experience and digital capabilities,” wrote Abhishek Bhandari in the report.

Therefore, the cost synergies will mostly be in the general and administrative (G&A expenses) functions. “G&A expenses could accrue through combination of marketing teams, facilities (like corporate headquarters etc) and administrative staff,” it said.

Biggest risk
According to the brokerage, the biggest risk in the merger could be a sharp rise in attrition at all levels in both companies.

This can be particularly hard in an industry that has “extremely high attrition rates” and in which demand for is “extremely strong”.

“While LTI’s senior leadership depth is high and could ensure continuity of its growth agenda, managing employee morale at lower levels could be a challenge… Assuaging concerns on role clarity for senior leadership of the two entities would also be critical to ensure that both the entities continue their growth agenda until the merger happens and even after that,” it added. Moneycontrol