Wednesday, January 7, 2009

Satyameva Jayatey Part II: The True Story about FIIs and the Satyam Board

This is a slightly long explanation of the Satyam controversy but interested private investors and policy makers will benefit a great deal from knowing the true Satyam story.
If you have been following the developments surrounding the 2008 credit crisis then you are probably aware that the current global macroeconomic environment is one of low levels of aggregate demand and deflationary pressures in the major world economies. Foreign Institutional Investors in the Indian stock market are free to invest in equities and other instruments across various geographies and sectors. If you had a choice of long term equity buys, which sector would you choose? According to me, the emerging markets infrastrcuture sector, specifically sectors such as the Electric Power Sector in India, offers an attractive opportunity to global investors due to the current macroeconomic environment.
While most sectors in various global economies are facing demand shortages, the Indian infrastrucuture sector continues to be in a situation of high levels of demand and low levels of supply. If you are an urban consumer of electricity, for instance, you would not appreciate disruption of power supply for an hour or two in a day. Urban consumers are perfectly willing to pay the additional electricity bill, and and saving from this amount makes little difference to the overall household budget.
When the announcement about the Satyam plan to acquire Maytas Infrastructure was announced, a controversy emerged on three basic counts:
a) There was a debate about the valuation of Maytas equity in the deal, and the fact that Maytas is managed by family members of Satyam's promoters seemed to indicate that the deal was a plan to siphon out Satyam's cash balances to a family run firm.
b) FIIs insisted that there was little value in the diversification of an IT firm into the infrastructure sector, and that investors could independently diversify.
c) FIIs debated that there is absolutely no synergy between the operations of an IT services firm and an infrastructure company.
Given the nature of this controversy there was a daily news flow in the Indian financial press and media, in which it was portrayed that the Maytas deal is a serious flaw in terms of the corporate governance structure of Satyam. the promoters, holding very little equity stake in the Company were planning to make an overvalued investment in a family run firm in another sector, to the detriment of the Foreign and Domestic Institutional Investors in the Company.
At that point in time I had no view on Satyam. The reason for my confusion about the Satyam story was my macroeconomic view that the Indian Infrastructure Sector is a good buy. I must admit that I did not go through the details and check whether the valuation of Maytas equity in the Satyam deal was fair or not.
What followed the Satyam-Maytas deal controversy was a veritable campaign against the Satyam Board of Directors by Institutional Investors, mainly the Foreign Institutional Investors . Independent Directors on the Satyam Board were blamed for their irresponsibility/complicity is passing the resolution to acquire Maytas.
The Board meeting to pass the resolution was chaired by Dr. M. Rammohan Rao, who has a position at the Indian School of Business in Hyderabad.
Dr. M Rammohan Rao is best known for his tenure as the former Director of the Indian Institute of Management, Bangalore. Dr. Rao is a scholar in discrete mathematics and he has won several international academic awards and prizes in that area. He teaches the application of mathematical methods to financial derivatives. Dr. Rao was a full professor at the New York University prior to his tenure at the IIM-B.
Dr. Rao also chairs various high level Government Committee. For instance, he used to be on a Selection Committee for the post of Deputy Governor of the Reserve Bank of India. In the wake of the Satyam-Maytas controversy a Member of Parliament wrote, questioning the appropriateness of having Dr. Rao on such Committees. The financial media reported with glee a couple of days back that according to them a meeting of this Committee was delayed and Dr. Rao was excluded from the meeting.
Other independent Directors included Vinod Dham, who is widely regarded as the father of Intel Corporation's Pentium Chip program, Dr. Krishna Palepu and one other Dr. Mangalam, both Professors at Harvard, I think. Mr. Prasad, another independent director, is a former Cabinet Secretary to the Government of India.
With the exception of Mr. Prasad, all the independent Directors resigned from the Satyam Board in the wake of the mass media and political campaign launched by the Foreign Institutional Investors.
As this controversy developed FIIs approached a wide range of "strategic investors" to buy out the promoter stake in Satyam; IBM,Oracle,HCL Infotech,Mahindra Consulting are some of the names here. The Satyam stock plummeted due to the controversy but the strategic investors were still demanding lower valuations if they were to think of a management buy-in. In the melee, the World Bank released information that they had earlier blacklisted Satyam due to Satyam having bribed Bank Staff members in return for favorable vendor contracts.
The bottomline of the whole Satyam-Maytas controversy was that the promoters, led by Mr. Ramalinga Raju, should sell their equity stake in the Company and resign from the Board. According to FIIs, this would solve Satyam's 'Corporate Governance' problem and help improve the stock's valuation.
While the independent Directors appeared to stand by the promoters initially, The Economic Times reported on the day following the controversial Board meeting that Satyam's COO and some other high level executives had put in their papers just prior to the Maytas buyout decision. This actually reveals that the FIIs had some Company executives on their side.
Overall, as events developed, there seemed to be little chance that the Satyam promoter will be able to sustain its position on the Satyam Board.
In the light of this background, Ramalinga Raju's resignation letter should be read accurately. What Ramalinga Raju has done, is that he has diverted a huge amount, in the range of around Rs. 7,000 crore from the Company and then resigned, with a letter claiming that the money was never there.
Now it will be virtually impossible to trace that money. Regulators are free to go and investigate Price Waterhouse Coopers, the auditors of Satyam. PWC auditors will say that the money was there when they did their audit. This won't be easily believed. Similarly everybody left in the Company, several senior Government officials, and some of the other businessmen in India Inc will all come on TV and express shock and surprise, etc at this development. Aspersions will be cast on several other IT firms.
All this jaw boning will presumably amount to nothing. Satyam now needs to be valued without that cash on its books.
I'm expecting that Ramalinga Raju will find ways to route the Satyam money to Maytas, just as he originally intended. I would therefore advise private investors to go long on Maytas with a 2 year investment horizon. There is no futures and options trading available on Maytas on the NSE. Buy Maytas in delivery and wait patiently till the Satyam storm blows over.
Maytas won a big contract from Southern Railways yesterday. It's trading at slightly above its 52-week low levels today.

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