Satyam - what should investors do ?

The Satyam fiasco has been written about from several angles — corporate governance, auditor omissions and commissions, and the plight of the employees. But with a depletion of 82 per cent in the stock’s value from the time the (aborted) Satyam-Maytas deal was announced, what should hapless investors do? Should they hold on to or buy the stock in the hope of a recovery? An analysis suggests that it may be best to stay away. Doubts about the very size and scale of the company’s operations, its murky financials and worries about how the company will raise cash even to fund its near term operations tilt the risk-reward ratio against any long term investor. A takeover of Satyam’s business in its entirety also seems unlikely.

Can’t be taken at face value

First, where does Satyam Computer stand relative to the top software companies, in terms of financials? That’s difficult to say, as Mr Raju’s disclosures have called into question almost every facet of Satyam’s financials and operations.

If his statements are to be taken at face value, Satyam’s revenues, and as a direct result, its operating profits were inflated by a fictional sum of Rs 588 crore (amounting to 22 per cent of reported revenues and 90 per cent of operating profits) for the September quarter. Shorn of this sum, Satyam’s operating profit margins would stand at 3 per cent, instead of 24 per cent as reported (OPMs for top tier software companies now stand in 25 to 35 per cent range).

But these numbers cannot be used to arrive at any meaningful “fair value” for Satyam’s business, for three reasons. One, given that he has admitted to falsifying numbers for several years, the veracity of the numbers provided by Mr Raju in his confession is subject to some doubt. Two, these disclosures pertain to just one quarter. Even if true, they represent only the most recent picture of Satyam’s performance; they may not represent the sustainable picture over a year or several years. Further, it is not clear if prior-period adjustments have also been taken into account in reckoning the “overstatement” in the books for this quarter. Clarity on these aspects may emerge only after a thorough investigation and audit of Satyam’s financials for the past several years.

Cost structure

Nor do the numbers in Mr Raju’s statement tally with Satyam’s reported operations. As per its quarterly financial disclosures, Satyam Computer operates in all the segments that the leading IT companies are in. The company’s September financials stated that the company had as many as 690 clients. This is much higher than Infosys, despite Satyam being half its size in revenue terms. This suggests a very large number of small clients.

Unlike Infosys, TCS or Wipro, Satyam does not have too many clients who are billed over $100 million a year, which may make for a less efficient allocation of resources, greater churn in the client base, and lower annuity-based revenues.

As much as 45 per cent of its revenues are claimed to come from enterprise business solutions and package implementation services which usually offer higher margins. Satyam again reports among the highest utilisation factors (nearly 85 per cent) among the software majors. The onsite-offshore mix is also very similar to most IT peers, indicating a reasonable cost structure.

But if the business mix is indeed as above, Satyam should be enjoying over 20 per cent operating margins, which its peers enjoy. That is at variance with Mr Raju’s claim of a 3 per cent margin for the latest September quarter.

The explanation could be that Satyam offered hugely discounted billing rates to its clients, in a bid to bag deals. Its utilisation factor could have been much lower than stated. Or worse still, it may have reported revenues from some verticals that have simply not materialised.

Either way, it is clear from these disclosures that Satyam has indulged in sizeable dressing up of both its revenues and profits, making it quite impossible for an investor to guess the actual size of the business, as it stands today!

The prospects

While Mr Raju’s disclosures have called into question Satyam’s financials, the company still has a strong business, isn’t it? After all, it does claim to have a large client base comprising of 185 Fortune 500 companies.

Let’s examine this aspect. A portion of Satyam’s ongoing projects that are fixed-price based (over 30 per cent of reported revenues) especially those nearing completion, may not be in trouble, as clients may prefer to stay on till completion to avoid disruption to schedules. But what of contracts that are billed on a “time and material mode”? Reports that Satyam does not hold sufficient cash as on date to meet working capital requirements create uncertainty about how continued operations will be funded; but the replacement of Satyam’s Board with a government-appointed one may ensure continuity of the business for the time being.

But even with a new Board in place, investigations launched by a slew of regulatory authorities, including the Ministry of Corporate Affairs and SEBI, also suggest that “business-as-usual” will not be too easy for Satyam. All this suggests that new clients, or those that are yet to commence with mission-critical projects such as those in infrastructure management services, may weigh a switching option.

Several large global IT deals over the last couple of years have been awarded to multiple IT vendors, who work on the project in tandem. Such clients have a ready option to reapportion existing projects among Satyam’s rival vendors.

Even otherwise, transition to other large Indian vendors such as Infosys, TCS, Wipro and HCL Technologies will be an immediate option available to clients. Their recent acquisitions display their commitment and continued interest in the IT sector — a test that Satyam failed.

A migration to global players such as IBM, Capgemini and Accenture is also possible. But if lower costs, relatively lower billing rates and established track record are the key criterion, Satyam’s Indian rivals may clearly fit the bill.
Takeover candidate?

With the stock beaten down to a fraction of its original value, will a potential suitor turn up for the business? For now, this appears unlikely for the business in its entirety. After all, what makes a company attractive for a takeover is its stock trading at a substantial discount to its intrinsic value or the assets in its books.

Going by Mr Raju’s letter, it appears that the company’s reserves and surplus may be insignificant. Apart from the share capital of Rs 137 crore that the company reports, everything else is subject to investigation. Of the total assets of Rs 7,381.3 crore in the 2007-08 balance sheet, there is an overstated cash and bank balance of Rs 5,040 crore, a non-existent interest accrued of Rs 376 crore.

Together with an overstated debtors position and understated liabilities a staggering hole of Rs 7,136 crore arises in the balance sheet. The land and plant and machinery on the books amount to about Rs 424.5 crore, making up only Rs 6.3 per share.

The other question raised is if a competitor may seek to take over the company for its domain expertise or execution skills. That would vest mainly with Satyam’s 53,000 employees.

This looks difficult again. With the world economic environment, especially in the US and Europe, in deep trouble, the business outlook for IT companies is challenging. Most large software players are looking at ways to optimise their existing employee base by tapping into bench strength and improving utilisation.

Under these circumstances, even large players may not be keen to take over the entire employee base of 53,000. They may see better value in adding to their talent pool by making selective offers or by buying out specific divisions of Satyam that appear attractive— such as its enterprise solutions offering.

A takeover will also inevitably bring with it integration and merger issues, which companies may wish to avoid in a challenging environment.

In this respect, the legal suit that hangs in balance with Upaid, a UK client, the class action suits now being filed against Satyam in US courts and the termination of the World Bank contract, all do not help matters. Upaid alone is seeking $1 billion plus in compensation for patent infringement, and the final judgement is awaited.

Considering all the above facts and with no clarity on what the real balance sheet numbers are, it may be too risky for a serious investor to bet on Satyam’s fate.

Salvaging whatever is left and exiting may be a better option

via Business Line