A cursory look at Wednesday’s market would be enough to show how the Satyam Computer Services Ltdscam has hit India—companies that in the opinion of the market have a question mark over their governance standards have been pummelled. The realty sector, with its complicated land bank valuations and revenues generated by sales to group companies has been the worst hit, with the BSE Realty index falling 16.95%. Housing Development and Infrastructure Ltd(HDIL) and Indiabulls Real Estate Ltdfell by 21%, Unitech Ltdby 20%, DLF Ltdby 16%, on a day when the Sensex slid by 7.25%. Nor were realty companies the only ones to be affected. Other companies that lost substantially included Suzlon Energy Ltd(-23%), Aptech Ltd(-25%), Lanco Infratech Ltd (-25%), IVRCL Infrastructure and Projects Ltd(-27%) and Nagarjuna Construction Co. Ltd(-22%). But it wasn’t just negative perceptions on corporate governance that pulled down stocks on Wednesday—there were concerns that funds that had Satyam in their portfolios may also sell other stocks they held. Some of these firms are highly leveraged—which seems to be the reason Satyam’s promoter group has ended up like this. Needless to add, it was also a situation in which short-sellers revelled and rumours flew thick and fast. But companies such as Infosys Technologies Ltd, Wipro Ltd, Hindustan Unilever Ltd, and Maruti Suzuki India Ltdgained.
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Corporate governance standards in India were supposed to have improved over the last few years, as the market rewarded those promoters who cleaned up their balance sheets and stopped siphoning off of money. But not much attention was paid to corporate governance during the easy money days of 2003-07. As Warren Buffetfamously put it, “It’s when the tide goes out that you realize who’s been swimming naked.” Corporate governance risk will increasingly be a factor that investors will pay heed to in future. Balance sheet risk in the form of derivatives and liabilities on account of foreign currency convertible bonds (FCCBs) is already weighing heavily on companies. The Satyam effect will add to that for companies whose promoters have a less-than-perfect reputation. The premium attached to good corporate governance should rise.
As an emerging market, India has already been suffering from risk aversion. The Satyam scam will add to that. According to a fund manager, the Satyam fraud has emerged at the worst possible time, when capital is scarce and investors are anyway pulling funds out of India. It has already scuttled the tentative rally that was taking place in the last few days.
Will the Satyam episode lead to tighter regulation and greater compliance costs, as happened in the US after Enron and WorldCom? With the elections so near, that may not happen. Moreover, the fraud at Satyam seems, at first sight, to be a very simple one—for instance, if, as B. Ramalinga Rajusays, the cash and bank balances of at least Rs5,000 crore were non-existent then all the auditor had to do was call for the bank statement and the deposit receipts to know that wasn’t true. Needless to add, the fraud brings under the spotlight the role played by auditors as also that of the so-called audit committee, which was headed by no less a person than professor M. Rammohan Rao, the dean of the Indian School of Business. In fact, one reason why trust has been so shaken is because Satyam was no fly-by-night operator, but one of India’s top IT companies, audited by a top auditing firm and having some of the best experts as independent directors.
But as one chartered accountant points out, “Satyam isn’t the only Indian company involved in fudging accounts.” Such cases abound—it’s just things haven’t come out into the open like this. For some reason that’s still not fully clear, Satyam’s promoter has felt compelled to spill the beans.
In hindsight, investors’ concern about Satyam’s corporate governance and relatively weak financial parameters should have been taken more seriously. Investors would do well to now apply these checks on other firms. Although Satyam has been among the top software firms in the country, its debt has been relatively high at about 90 days’ sales. Similarly, cash flow generation has been among the lowest as a percentage of sales. For these reasons, the Satyam stock has always quoted at a substantial discount to its peers. Normally, accounting irregularities show up in the cash flow statement, but the scale at which Satyam’s fraud has been done, even cash has been doctored with. Still, relatively low cash flow is certainly an alarm bill that investors shouldn’t ignore.
Satyam’s operating profit margins, too, were the lowest among the top firms. But Wednesday’s revelation that margins are actually at 3% and not the reported level of over 20% is a complete shocker. Even the smallest of IT firms have better margins in India and Satyam boasts of much larger clientele and would certainly bill these clients at higher rates compared to tier-II and tier-III firms. The assertion that the company’s cost structure is disproportionately large too doesn’t make sense. Firms such as HCL Technologies Ltdthat have a comparable size have an operating margin of 20% or more. An IT analyst with a domestic firm is in complete disbelief about the statement that the company has a profit margin of 3%.
This statement about low operating margin doesn’t quite seem to add up. Perhaps Raju is lying again—if he has been doing it for so many years, there’s no reason why we should accept his entire confessional statement as gospel truth. There is much more clarity that is needed, but meanwhile one of the theories that’s doing the rounds of the market is that Satyam indeed generated significant cash, which has been siphoned off to fund the promoter’s other business interests. Instead of disclosing this, Raju now says the cash was never there. There’s certainly much more to the Satyam saga that will unravel in the days to come.
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Graphics by Paras Jain / Mint