A Russian general named Grigori Aleksandrovich Potemkin is believed to have built fake villages in 1787 to impress his empress Catherine II that the areas he had recently conquered for her were thriving. The monarch is said to have been impressed with what she fleetingly saw from a distance. The Potemkin village has since become a metaphor for deceit and deception.
It is now quite certain that B. Ramalinga Raju has built a sort of Potemkin company whose impressive façade hid a damaged interior. Satyam Computer Services has exaggerated its cash reserves, its sales and its profit margins. The question is: Why didn’t anybody realize this earlier?
Illustration : Jayachandran / Mint
Institutional investors, the board of directors, the auditors as well as the research analysts who cover Satyam for brokerages and journalists who write about the company have made the same mistake as Catherine II made more than 300 years ago: They were impressed with what they were shown and hence never bothered to take a closer look at the company.
The independent directors are particularly at fault, since it is their fiduciary duty to ensure that those who manage a company do not keep investors in the dark. Sceptics are now bound to ask whether Raju has really told the truth in his Wednesday letter or whether there are still more lies to cover the reality, the Mark to Market column quite reasonably asked in the Thursday edition of Mint.
So, is there no way of knowing? It will always be difficult to spot a fraud of this size, though we disbelieve Raju’s contention that nobody at Satyam was aware that he was fiddling with the numbers.
Red flags usually start fluttering in a company’s cash flow statement. The Satyam management has even falsified its cash position, usually the most transparent part of a firm’s financial statement. Yet even what was available to the public showed that the company’s cash generation as a percentage of sales was very low by industry standards.
In response to the Satyam scam, investors in other companies have reason to take a hard look at the companies they have put their money into. The boom years saw money pouring into companies because of parameters such as order book positions, land bank valuations, sum of parts and other variants of financial alchemy.
The slowdown and the Satyam revelations should drum some sense into the investment community: watch cash flows, for cash is king.
Could the fraud have been spotted earlier? Tell us at firstname.lastname@example.org