The recent fracas about Satyam Computers is a really fascinating story. Satyam (a computer software firm) was about to buy two real estate companies: a listed company named Maytas Infra and an unlisted company named Maytas Properties. They were going to pay roughly $1.6 billion.
This was a troublesome transaction from so many points of view. First, it would deplete the firm of cash. Second, it would mean defocusing the firm away from software towards real estate. Even if diversification into real estate were the goal, there were better acquisition targets around like Unitech. The case for buying these two companies seems to have been influenced by the shares held in the two companies by managers of Satyam.
Sounds bad? The cynic would say corporations make a lot of murky decisions, fumbling thorugh a variety of conflicts of interest. Indeed, all of management seems to be about overcoming agency conflicts. These kinds of malpractices have taken place in India for a long time.
This time, something new happened. A firestorm of protest broke out amongst shareholders -- particularly foreign shareholders -- and the press. The share price of Satyam crashed and the transaction was aborted. Here's the interesting media coverage:
- Dhiraj Nayyar in Financial Express.
- Saubhik Chakrabarti in Indian Express.
- An editorial in Indian Express.
- P. Vaidyanathan Iyer in Financial Express.
- Manas Chakravarty in Mint.
- An editorial in Mint.
- Shobhana Subramanian in Business Standard.
- Rhys Blakely in The Times.
- Nandini Lakshman in Business Week.
- Lison Joseph in Mint.
- A story in Hindu Business Line.
- An editorial in Business Standard.
- An editorial in The Times of India.
- Sukumar Ranganathan has text of an interesting email (which may or may not be authentic).
- Pankaj Mishra and Deepshikha Monga in Economic Times.
- Legal problems in the US.
- Rich Duprey on The Motley Fool.
- K. V. Kurmanath in Hindu Business Line.
- Aarati Krishnan in Hindu Business Line.
- An editorial in Hindu Business Line.
I was reminded of Niall Ferguson's characterisation of democracy and capitalism as two strands of a double helix; both come together to give us well functioning societies. A decade ago, the institutional shareholders would have been clubby PSUs. Without financial globalisation, foreign shareholders would have been missing. Without the free press that India has, the episode would have been buried in the back pages. In the event, India worked well, and Satyam was the cynosure of all attention on these days. On 16 December, there were just 36,000 trades worth Rs.49 crore for SATYAMCOMP on the spot market (i.e. "CM") on NSE. On 17 December, this jumped massively to Rs.1,340 crore off 0.7 million trades.
I think the most interesting questions to ask in this fracas are:
- What were they thinking?? Why did they do this?
- Did share prices show some action before the event?
- How much value was destroyed?
- What happens next?
Why did they do this?
One of the good approximations that's found in India, to the modern dispersed-shareholding corporation, is Infosys. They have 16.5% promoter shareholding. By these standards, Satyam has a remarkably small promoter shareholding of 8.6%. They have 61.57% shareholding by institutions of which 46.86 is made up by FIIs. There is a large ADR with 19.4% of the company.
With such a power structure, why were the managers so brazen? Did they not know that they serve at the pleasure of investors, particularly institutional investors and most of all foreign institutional investors?
A few days ago, I wrote a blog post Goodbye great moderation, hello financial fraud?. In this I argued that we might see an upsurge of illegal / ethical activities when businessmen have their backs against the wall. This perspective gives us some insight into why the managers of Satyam behaved the way they did.
What do we see in share price data?
A careful examination of share price fluctuations, net of industry index movements, is a valuable tool to understand the information that is available to insiders (who routinely trade or leak information into the Indian equity market). A comparison of Maytas Infra against the CMIE stock market index for industrial construction companies is instructive. From roughly 23 September 2009, the industry index and the overall Cospi dropped quite a bit. But Maytas Infra held up well. Even though things were very bad for Cospi and even worse for the industry index, Maytas Infra stayed put. Perhaps the people trading Maytas Infra knew that they had a `Satyam Put'.
Here's a summary of stock market returns on the products of interest:
16 December was the last happy day. But by 16th December, while the overall Cospi had gained 4.82% when compared with 31 October, Satyam had already lost 25.63% and Maytas Infra had gained 11.91%.
By 19 December, Satyam had lost another 28.18% and Maytas Infra had lost 48.87%.
Note that the broad market index, Cospi gained in both sub-periods: It went up by 4.82% in the first phase and 2.08% in the second, adding up to overall returns of +7%.
How much value was destroyed?
Let's tote up the value destruction in the three days from 16 to 19 December. All values are in crore rupees.
|16 Dec||19 Dec||Delta|
So in three days, the market value of Satyam dropped by Rs.4262 crore and if you add in the drop in market value of Maytas Infra, this comes to Rs.5,644 crore. But as argued based on the share prices above, the story probably runs deeper and share prices of both companies were in motion based on anticipation of these events prior to this. If we start at 31 October, the picture is:
|31 Oct||19 Dec||Delta|
So over a date range in which the broad market gained 7%, the mistakes made by the managers of Satyamcomp managed to destroy Rs.10,640 crore.
What happens next?
These recent events have already been a path-breaking experience. In India, it is rare for owners to rein in managers in this fashion. But I suspect the story is not over. A few more path-breaking elements of the story might be in store for us.
- What would you do with a manager who lost Rs.9,560 crore? I suspect that in most well governed countries, the manager would get sacked. It would be interesting to see (a) What the institutional investors of Satyam think, and (b) How the Indian legal environment deals with this. P. Vaidyanathan Iyer's article in Financial Express (linked above) is the first one to mention this possibility.
- One of the consequences of doing an ADR is that the firm submits to US rules about investor protection. I am curious about the legal position of the managers of Satyam and how that aspect might unfold.
- The firm is holding a remarkable amount of cash [statement]. Of a balance sheet size of Rs.8,800 crore, cash and bank balance is Rs.4,461 crore. The only reason for a company to keep retained earnings is if it will produce returns that are superior to the broad market index using this cash. If this is not the case, then the board of directors should insist that cash is paid out to shareholders who can atleast invest in an index fund and obtain the performance of the broad market index. It is better for investors to diversify rather than for firms to diversify.