What lessons did you learn from the takeover bid by Reliance Industries (RIL) in the early 198Os?
We were partly responsible for it. The company had not had a very entrepreneurial approach over the years. If a company is cheap and doesn’t have a single owner with a large shareholding, it becomes a takeover target. RIL moved in only after it saw a threat from the Dubai-based Chhabrias, who had started acquiring L&T shares from the market. Despite repeated attempts, Reliance couldn’t take over, because the financial institutions were opposed to it. Moreover, employees were unhappy, because it meant losing their independence and becoming a part of another group. At that time, I was one of eight board members who were resisting the takeover. But where I really played an important role was when Reliance sold its stake—10.4%—to the Birlas. I led from the front, and believed that since L&T was created by its employees, it shouldn’t be handed over to the Birlas. So I fought tooth and nail against the deal.
But why are we to blame? Because the company was too bloody cheap. Its stock had stagnated for 20 years up to 2002. It stayed in the range of Rs 140 to Rs 150 during the early 2000s. Even when Mr. [Kumar Mangalam] Birla [chairman of the Grasim group] made an open offer in 2002, it was only Rs 190 per share. And that was at a premium. I had decided to give employees stock options at the market price of Rs 178 per share, but at that time they didn’t realise the importance of the gesture. I knew it was the best way to incentivise and create value. Thus I started my transformational journey for L&T. To me, the logic was clear: The more valuable you are, the less is the threat of a takeover. You become so expensive that nobody is interested in you.
What did you do to stave off future takeover attempts?
The first thing I did was to make a deal that the Birla group could only have the cement business, provided they transferred their 15% stake to the L&T Foundation, a body created by L&T employees. Before the takeover bid in 2002, I had never met a politician. But then I started knocking on politicians’ doors, because here was a village boy fighting one of the biggest corporate families in India.
For the sale of the cement plant, there were many arguments. Most of my meetings with the Birlas ended in chaos because I’d never agree to their proposals. Because there were eight members on their side and eight on ours, most discussions ended in a stalemate. Even having a nominee of the Life Insurance Corporation didn’t help. I told the Birlas: Although I was willing to sell off the cement business it was a non-core one, I wanted a competitive price. I wanted to ensure that other L&T businesses were protected from takeovers. After months of negotiation, I agreed to sell, after they decided to transfer their stake to the L&T Foundation. The deal was Rs 140 per share for the engineering division, and Rs 171 per share for the cement business.
Rather than a threat, the deal was actually an opportunity for us. At the time, we had a negative EVA, and had been downgraded from AAA+ to AA because our debt-equity ratio was 1.1:1. I showed the board that from 1979 to 2003, L&T suffered, as we borrowed money to run our cement plant, because it’s an asset-heavy company. We had to repeatedly raise equity for it, and our equity swelled to Rs 250 crore, but the share price never rose. The L&T share price stayed between Rs 30 and Rs 45 in the 1980s, then went up to Rs 120 to Rs 130 by early 2000. So we were selling our equity cheap.
To start the process of transformation, first I asked my employees whether they wanted to remain as they were, or become part of another group. They were unanimous that they wanted to remain an independent entity. I said, if you’re hardworking, you’ll create value, and if you’re a professional you’ll still create value, and if you’re a professional and have great leaders, you will still only add value. But if you are an entrepreneur with outstanding leadership skills, and are in a professionally managed company, the minimum multiplier value will be 10 times.
Make yourself so expensive that nobody can touch you. In the bargain, your stock will move up and create value for yourself, too. So, the day the deal with the Birlas was agreed, I told the board that the cement firm’s debt, too, had to be transferred to the other company. When the deal was finally sealed, the L&T debt-equity ratio was at 0.2:1, and my equity was down to Rs 25 crore. But after that, I added a lot of value to the company and gave out bonuses in 2006 and 2008. Today, L&T is nearly a Rs 50,000 crore company. But the equity is only Rs 125 crore. Financial institutions and the employees have a 43% stake.
Tell us about your transformational journey since 1999, when you became CEO.
Before I was made CEO, I knew I’d occupy that post one day. So I already had a blueprint in place. All businesses were put in four buckets. In the first, I put non-core businesses that needed to be sold immediately. The second had companies that were adjacent to the core, but small and not scaleable, and we needed to sell them. The third bucket was for businesses that we wanted to grow and sell, such as cement, which I grew from 12 million to 17 million tonnes before selling it off. The fourth bucket was our core businesses, which we wanted to grow at all costs, so each company would have a revenue of $1 billion (Rs 4,531 crore). Our transformational journey is only 70% complete. There’s a long way to go.
What were the other problems that you faced during that time?
Between 1974 and 2000, L&T’s HR policy was one of the worst. It became a seniority-driven company. When Mr. Larsen—the founder—and his team left, merit ceased to be a criterion for promotion. Till 1974, I was the fastest achiever in the company, beating IITians, MBAs, and foreign-returned engineers. Once the Indian management took over, it became a struggle for me to grow. It took me nearly six years to be promoted from joint GM to GM. Even so, I never thought of leaving the company, although there wasn’t a corporate house in the country that didn’t try to hire me. Offers also came from public sector enterprises. You know what former Sebi chairman M. Damodaran used to say? ‘If you take A.M. Naik’s skin off, you’ll find millions of L&Ts coming out from his blood.’ I always say that if you have devotion, passion, and conviction, you can conquer anything.
The loss of meritocracy meant that many good people left. I can give you at least 20 names of former L&T guys who have done very well in America and elsewhere, who went away. They couldn’t see the sky, because the company became so hierarchical that we would ask, ‘Which batch is he in?’ ‘You’re from the 1978 batch, so you won’t get it because there’s someone from the 1977 batch.’
So what did you do to change the system?
From 1989, after I joined the board, I started making changes. But I could achieve little, because most of my proposals were rejected by other board members. Even when I became CEO in 1999, my proposal to put meritocracy on the fast track was rejected. Seven of the eight tables where board members were seated said no. Only my table said yes, because I was the bully sitting there.
So, talk of succession planning has been on for 25 years. Because of bad HR policies, many people who would have been in their early fifties and in senior management positions by now, have left. In L&T, people became GM at age 55, vice president at 58. Those who stayed back were the ones with a strong sense of belonging to L&T.
When I started changing the system, there were lots of opportunities for engineers. In the old days, there were only L&T and Telco, and we could confine our recruitment of engineers to the IITs. Wherever you go today in the world, those who are 50 to 55 years old say they did their training at L&T. Then came the temptation of the IT sector. Today, six out of 10 IITians go to the U.S. Out of the remaining four, one goes on to management school and joins an investment banking or FMCG company. Two of the remaining three go to IT companies. So for old economy companies, only one candidate in 10 is left. Here I’m talking of the top 25% of students. Hardly anyone wants to join a construction company, work on projects, and stay in jungles, building this and that. So L&T is at the bottom of the recruitment ladder.
So I started training programmes for employees, and said the only way to grow is to let ordinary people do extraordinary tasks—convert employees into L&Tites. This conversion would not only bring stability to the company but also counter our inability to attract the best talent. But now, brighter people come to us because the value of the L&T brand has multiplied many times.
What were the some of the other challenges that you faced?
The world had changed, the media became active. Analysts in the media track every sector, and they say they don’t understand L&T because it’s a conglomeration of unholy alliances, because many divisions such as cement were not aligned. I remember a British analyst wrote an article in 2002, saying L&T was a great company that unfortunately never had a great CEO. Then he went away to London. And he wrote in 2008 that the best thing that could happen to L&T was that it had one of the best CEOs, because my restructuring and the improvement in the economy finally started showing results.
Do you think hostile takeovers are a thing of the past now?
It may be possible once this management goes and a new generation takes over. In our case it was different because we gave our life to L&T. Second, if the L&T share price were to drop sharply then the financial institutions will not stick to the terms of the agreement because nobody wants destruction of value. So, you have to constantly create value. And in such a situation if L&T becomes cheap then you become vulnerable and that is what I keep telling people. That 15% stake may not be enough to protect the company, but it could be a different matter if the stake were to go up to 30% to 35 %. But the problem is that because share prices are so high, we cannot afford to buy them from the market.
Tell us about the restructuring that you’ve done recently.
We asked consultants McKinsey and Bain how we could continue to grow profitably—the company has been growing at a compounded annual rate of 22% for the past five years—in a globalised world. What line of business do we need to stay in? What structures and systems do we need? After 18 months of brainstorming, we came up with a hybrid holding company model, which will have both independent companies or verticals, and subsidiaries, in its fold. The point is to reduce the complexity of the organisation—go from 152 businesses groups and 64 strategic business units, to a more manageable nine verticals and six subsidiaries. All these verticals will have independent boards and run as listed companies, though they may not actually be listed.
That would make them more competitive, but they’ll ultimately report to the overall L&T board. This board will now act as an investor, deciding which vertical will get what amount of money, and not work as an operator any more. Not only would this make listing these companies easier, and unlock their true value, but it would also let investors choose companies for investment. First, the subsidiaries will be listed, and later, when the verticals are ready, they too will be listed. I plan to make them 75% ready for listing before I leave the organisation in September 2012.
In one of your interviews, you said all the nine verticals will be listed in the chairman’s office. Can you explain what you mean by that?
Well, the aim is to ascertain their market cap by some scientific method. This is required, because finally we’re going to partly link senior leaders’ remuneration to the performance of their companies. So far they benefited regardless of performance, because there was one company balance sheet. Now I’ll have nine balance sheets, though the outside world will see L&T as one listed entity. A new management information system has been designed. Since international financial reporting standards will kick in next year, my policies will only help the company. I’m making accounting more transparent to help analysts understand L&T better. They don’t understand where we’re investing—in defence, power, construction, and so on. When I find that listing will give a vertical exponential growth, I will list it, as I’m doing with L&T Finance. If we get a banking licence, I’ll position it as L&T Bank.
How are you so confident that you will get a banking licence, given that you are not a financial company?
If there’s one company that should get a banking licence, it’s L&T Finance. We’re a financial company, and financial institutions hold 31% of our shares. If I don’t get the licence, I’m going to rock the whole country. According to our survey, most people will pull out their deposits and put it in L&T Bank. We’re a name people trust.
You have been with this company for 46 years. Why haven’t you groomed a successor?
First, tell me who groomed me? I’ve never, never gone to my boss in my 45 years for help or guidance. I’m a self-made man. L&T gives you the freedom to succeed, and you have to be your own teacher. Secondly, I was always doing things expected from a person two levels higher. And every time I tried to bring up somebody laterally, the seniority policy came in the way. You people should track the last 35 years of L&T history. We could have done this in the 1980s—bring in talented people who were 15 years younger than us, and who would now be occupying important positions.
I did bring in Ravi Uppal from ABB. But he’s never done manufacturing; he’s a sales person. It’s taken 2½ years to orient him. He’s come a long way from the multinational mindset—from a product to a project mindset, to dealing with Indian bureaucracy. I had to have six or seven meetings with him, he still has a long way to go in understanding the whole project syndrome.
I brought in the engineering services CEO from Satyam, Keshav Panda. He’s damned good. I handed him a company at $40 million. Last year, he had brought it up to $70 million, and he’ll take it to between $120 million and $180 million. I’m helping him because he’s proactive. I’m also talking to a person who may be the CEO of our realty business. I’ve had two or three meetings with him.
We’ll have 16 or 17 businesses. I want 16 CEOs. I have 11 CEOs, and need to look for five more. I need CEOs who are around 51 or 52 years old. But the real challenge is to get them accepted within the company. Get me a leader who has started 60% of the company’s business, knows every business and corner of L&T, and who has spent 46 years—or 100 years of manpower—in intelligent thinking, passion and devotion with conviction, and who prepares a balance sheet for every hour of work he’s done. I will take him laterally. Great leaders are born once in a decade. You’re not going to get another Sachin Tendulkar in 50 years.
Since all the independent companies need independent directors, are you looking out for them?
We’ll need at least 27 independent directors. We now have 11 directors and we’ve selected another nine, who will go through the nomination process. They’re all outsiders, knowledgeable and of good standing. One director from L&T’s parent board will also be on the board of each vertical. McKinsey and Bain will be roped in as consultants, to ensure we actually implement what we’re supposed to. Of course, we should have done it five years ago, but now, don’t ask me why we didn’t do it before. I started this only in 2009, and the company is so complicated that it took us 18 months to achieve this. We should have started in 2005, but I did make a beginning through the concept of operating companies in the last five-year plan. It did not work, because there was no implementation.
Finally, how does Mr. Naik expect history to remember him?
I want to be remembered as the person who made L&T belong to employees without taking a penny from them. No one else in corporate history has done such a thing. I’ve also ensured that a workers’ representative is on the board. I made employees trust L&T’s owner and biggest shareholder. You know what Mr. Birla told me after signing the deal? ‘Mr. Naik, history will remember you for what you’ve achieved. You’ve now made employees the owner.’ These are his exact words after we shook hands.
