Mumbai: A day after the Satyam Computer Services Ltd scandal broke, UK-based independent investment bank Noble Group released a report that points to widespread accounting lapses across the broad index of 500 Indian companies listed on Asia’s oldest bourse, the Bombay Stock Exchange (BSE), and warns of “more Satyams in the pipeline”.
The report suggests that as many as one-fifth of these companies have accounting issues. Noble Group was “disappointed but not surprised” by the Satyam development.
Cheat code: Satyam Computer Services headquarters in Hyderabad. Mahesh Kumar A. / AP
“Our experiences over the past few months...suggest that manipulative accounting and aggressive promoter practices are more common in India than is generally believed to be the case,” the report says.
The group’s analysis shows at least five types of accounting malpractices exist across BSE 500 firms—among them, recording revenue ahead of time, booking “fictitious” sales, expense manipulation and cash manipulation.
At least 30 companies, the report says, recognize revenue at the time of sales. This, it says, is disclosed by worsening cash flow from operating activities despite a rise in earnings before interest, taxes, depreciation and amortization, or Ebitda, a widely used measure of profitability.
At least 60 firms on the index, the report says, seem to have booked sales that might actually have come from investment income or other income.
Also, reducing depreciation rates to push expenses to a later period is noticed in at least 10 companies. And at least 15 firms have handed out the bulk of their loans and advances to companies in which their directors have an interest.
“Pump and dump” and “blab and grab” are among the more popular ways that promoters use to push their stock up, according to the report. In the former, the promoter “pumps” up the stock to generate liquidity, follows it up with announcements that send the price up and then “dumps” the holdings.
In the latter, the promoter announces a new venture, even when it has nothing to do with the company’s main business. This infuses fresh funds, which the promoter “grabs”, but then sells his/her own holdings. The new venture is then conveniently postponed, sending the stock price down.
A third method promoters use is to simply siphon off funds during bear markets, when the pressure to show strong earnings is less. The most common method, the report says, is to inflate “other expenses” or “sales and distribution expenses”, or even “miscellaneous expenses”. In bear markets, the report says, such expenses rose by almost 25% (as a percentage of operating expenses).
The problem exists on three fronts: lax accounting rules, weak market regulation and corporate corruption.
In the first category, the report says, there is a lack of restrictions on auditors to do consulting work for the firms they audit.
Second, the Indian market does not seem to place restrictions on how quickly after the year-end a firm has to publish its annual report, which deprives investors of a timely look at the true state of affairs. The report also castigates market regulators that are driven more by political decisions.
And the third fault-line lies, the report says, with the promoters, whose powers are largely unchecked by directors, auditors or regulators.
Still, in the face of all the doom and gloom surrounding Satyam, the report says this is the best time to invest in India, as the markets are unprecedentedly cheap, noting that such scandals do not appear to have an overall bearing on market direction.
Investors must do three basic things before they open their wallets—primary data checks on management, forensic financial analysis and in-depth interviews with management.