Sunday, December 21, 2008

Crisis at Satyam

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:

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:

Date Satyamcomp Cospi Maytas Infra
31 Oct 304.65 1304.96 429.95
16 Dec 226.55 1367.90 481.15
  Change -25.63% +4.82 +11.91
19 Dec 162.70 1396.43 246.40
  Change-28.18% +2.08% -48.87%

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
Maytas Infra 2832 1450 -1381
Satyamcomp 15227 10964 -4262
Total -5644

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
Maytas Infra 2530 1450 -1080
Satyamcomp 20524 10964 -9560
Total -10640

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.

16 comments:

  1. Hi Sir,

    I think group of large shareholders like Aberdeen Asset Management, Fidelity, Lazard et al may / should get together to buyout Satyam's promoters stake and then approach Infosys/Wipro to take over Satyam.

    Ousting Ramalinga Raju and team won't be difficult, the question really is, do we have shareholder groups like those of Eddie Lampert, Boone Pickens, and the likes. I think we might (or I am hoping) see that happening this
    time around.

    Ramalinga Raju's days at Satyam are limited, I think.

    ReplyDelete
  2. For the managers to get sacked they don't have to get bought out! They
    only have 8.6%. They serve at the pleasure of the shareholders. Look
    carefully at the shareholders - if 10 to 20 of them get together, it's
    a done deal.

    See:

    http://www.business-beacon.com/kommon/bin/sr.php?kall=wcoshv&repnum=654&cocode=214297

    ReplyDelete
  3. Yes, I agree. Promoter's in this case can simply be asked to resign. And not just the Promoters, but the entire Board that's been paid as if they are running the company's day-to-day operations. Rs.1.5 crore in cash and another crore plus in stock for Independent Directors, phew!!

    http://blogs.livemint.com/blogs/initial_private_opinion/archive/2008/12/17/satyam-name-and-reputation-are-upside-down-2.aspx

    ReplyDelete
  4. The major shareholders table mentioned above is here.

    ReplyDelete
  5. Sure, the CEO can be sacked - the family may not have the shareholding - but who takes over? And have the independent directors covered themselves in glory? Can they be trusted to appoint a new manager? At least, the deal was cancelled because the family had a reasonable stake. Would a professional have conceded "defeat" as easily or would ego have got in the way. My own take on some of the issues is at http://blunderbussinmumbai.blogspot.com/2008/12/satyams-shenanigans-and-related-issues.html

    ReplyDelete
  6. Satyam's performance over the last decades cannot be questioned. it has proved itself consistently time and over again.
    we should not jump to conclusion without understanding the merits of this acquisition story. Media should play a constructive role rather than be a party to the episode.

    ReplyDelete
  7. Sir, one angle which needs to be considered is Satyam's legal tussle with Upaid (in UK). A billion dollar claim from Upaid and a billion dollar in Cash / Bank balance was not a good idea ???

    And the best way to deplete the reserves but not partuing with them is what we have seen Satyam doing.

    Infact this is serious trechery, because at below 9% promoter holding the non-promoters were to be cheated by buting out the Maytas companies, where the Raju family had substantial holding.

    Investor activism is the need of the hour, and a quick reaction is of utmost necessity.

    ReplyDelete
  8. Anonymous:

    Satyam has done well over the past 10 years and there is no doubt about that. But, that, in itself cannot be an excuse (or a reward, if the promoters were thinking on those lines) to abuse shareholders money in the way Ramalinga Raju and Co. proposed to do.

    ReplyDelete
  9. Of the two Maytas companies, one had a son of Raju (the founder of Satyam) as vice chairman, and the other, newer real estate company had another son as CEO. Raju did not explain the transaction either before or after he decided not to take over the two companies; nor have I seen any justification of the prices proposed to be paid. I do not know whether the proposal to buy the two companies was good or bad; Raju never disclosed the information. The lesson to me is that CEOs of public companies have to communicate with shareholders.
    The suddenness with which Raju gave up on the idea suggests to me that the Upaid suit - in a Texas court - is financially significant.

    ReplyDelete
  10. "share prices of both companies were in motion based on anticipation of these events prior to this"

    Ajay, you went over this bit of your post unremarked. Why should there be "anticipation" of an event like this? Who were the people placing large blocks of trades in the run up to the announcement. Perhaps the answer to this seemingly irrational proposal, lies in what went down prior to the announcement.

    ReplyDelete
  11. while the decison of Satyam's mangement was hasty , let us not be hasty . Changing the mangement of an IT company is not that simple. we should ensure there are better safegards in the goverenance to avoid such unilateral decisions. Let us not give this company into foreign hands.

    ReplyDelete
  12. World Bank confirmed yesterday that Satyam has been barred from doing any work for 8 years.

    Read details on fox news.

    This fraud was planned and executed by Ram Mynampati and his direct report Raj Asava. Senior executives like T. Hari, Shailesh and Prabhat were active and willing participants.

    Some of these corrupt executives who benefited handsomely have now left Satyam. Why blame Raju and his family alone for the crimes of these corrupt executives? Name these people and shame them.

    ReplyDelete
  13. While I feel a management change must be forced, I understand it is not so easy and has not happened in India before, at least one that is forced by MFs, PEs or FIIs. MFs and investors in India have largely stayed away from such a move for a simple reasons i.e. finding a new management is easier said than done. and there is little guarantee the new professional management will be the best.

    ReplyDelete
  14. When the investors around the globe are so jittery, an event such as this makes the things worse for Indian Markets. Whats the difference between this and the episode of Bernard Madoff? Both had access to someone else's money, and played with the money without any thought of responsibility. I respect the acheivements of Satyam's managers in last 15 years, but that in no way gives them the right to play with someone elses investment. There are more budding companies in India, who need global investors. An episode such as Satyams seriously dents opportunities.

    ReplyDelete
  15. There are some interesting comments on this blog post here.

    ReplyDelete
  16. Chairman of Satyam Computers, B Ramalinga Raju had a heart attack at 8 pm on Monday 7th September, 2009. After the Heart attack he was taken to government-owned Nizam’s Institute of Medical Sciences (NIMS) at Panjagutta. He was immediately taken to the ICU. Now his condition is said to be stable.

    ReplyDelete

Please note: Comments are moderated; I will delete comments that misbehave. The rules are as follows. Only civilised conversation is permitted on this blog. Criticising me is perfectly okay; uncivilised language is not. I delete any comment which is spam, has personal attacks against anyone, or uses foul language.