Satyam

When you reward or even rescue the bad guys you screw up in two ways. One, you introduce moral hazard. That is, if there's no punishment for doing anything bad, then why not do it?

When the US government bailed out JP Morgan by ensuring it would buy Bear Stearns, it set a precedent, and later paved the way for rescues of AIG, Citi, Goldman Sachs and then, the auto majors. There's no need to be profitable, because if you're not, the government will come in and help.

Second, the allocation of capital is highly inefficient. That GM or Ford will continue to exist will halt the flow of capital to new, innovative entrepreneurs in the industry. That Citi exists today or that AIG not only takes capital towards them (and away from newer folks) but also ensures that no one could salvage the broken up CITI or AIG; something that may have been far better, and is likely to be even now.

This argument applies to Satyam too. We should let it die. The good folks there can go out and set up smaller companies, and execute the contracts. The rest will look for jobs anyhow. Satyam's resources get auctioned, at prices that make the newer companies viable. A new set of companies emerge, untarnished by Raju, some of whom will become the Infosyses, Wipros and Cognizants of tomorrow.

This will mean pain in the short term, for everyone involved. But a government interference cannot have a short term goal anyhow. In a few years, it will all even out and even better opportunities will be available to those that are currently drawing their paychecks from Satyam.

But if we rescue Satyam the moral hazard of frauding a company will exist, for others who have low ethical standards; and there are enough of those. And we'll end up sadding disgruntled employees with distrusted customers, a suspicious market and a financial industry unwilling to lend. Indeed, a better approach is to have it go bankrupt, cut it up into small pieces and auction each piece to the person that will pay the most - and we'll encourage a better set up for tomorrow.

Piped dreams, surely. I only expect more drama. For nothing.

The finance minster of India, widely believed to be Manmohan Singh, announced appointment of Ramalinga Raju, Chairman, Satyam Computer Services limited, as Director, SEBI. It is understood that Raju has been awarded for the international recognition and reputation he brought to Satyam Computer and Indian IT industry.

“Raju could create wealth where none existed. He could bring cash in access of what could have been counted. He could make Satyam earn interests on NPAs, and he could write off huge liabilities. Such an acumen and ability is not to be found easily in men, and India could benefit from his experiences in these troubled times.” a finance ministry press statement revealed.

Raju "overstated" cash by 5040 crore, meaning that money does not exist. Interest of 376 cr. on that non-existent cash, also does not exist. Naturally. Satyam needs to pay someone 1,230 cr. because Raju took the money, or so he says. And they're supposed to get 490 cr. not 2651 cr.

If Satyam were a bank, they would call it an "asset-liability mismatch". Most likely the US government would buy its bad assets (replace the non-existent cash, for instance) and take over the loans it was never supposed to have.

But Satyam is not a bank. (Hint: Maybe apply now?)

So what happens? There is no money, so how do they pay salaries? Employees are quite likely to look for other jobs - and understandably so. Satyam has 53,000 employees, and if you take the cash - at what, 400 cr. (not accounting for the liability) - that's about 80,000 per employee, but I assume they will need to pay electricity bills, rent etc., so it won't even be that much.

But this is a bad job market, and 53,000 resumes aren't going to be absorbed just like that. Still, customers will be wary; and may withhold payments or even abort contracts.

That would normally be a positive for Infosys, Wipro and TCS, but corp governance of India is under question here. Corporate fraud of this nature does not unwind easy; everyone will be suspicious.

With Raju behind bars soon, and no trust in the top management, and no cash, Satyam is likely to go under. No more acquisition crap - no one will want that. So bankruptcy will be the only way to go. If they owned any land, you can bet your last dollar it was mortgaged to the hilt - or, conveniently transferred to promoters and rented to Satyam through back-dated agreements, like we've seen in other cases.

So the impact, for employees, is sad. A company they work for, that they believed was fair, is going under for no fault of theirs; and indeed, no one other than the board, the auditors and the management is liable. In all likelihood the company is bust, and the shares are worth ZERO.

This is horrible for a lot of sectors. Real estate, in Hyderabad for one. The number of payment defaults will be massive, I imagine, plus the rentals should fall dramatically. Consider also that Maytas Infrastructure is run by Raju's son, and is likely a co-player in the whole deal - and that company was supposed to build the metro and all sorts of infrastructure projects.

Banks - both those working with Satyam (53,000 account monthly credits will be gone), and those that have lent to employees (personal, credit card and home loans). Who? We'll have to find out. ICICI bank is down 10% as we speak, HDFC 4% and a number of other banks are hurting.

Auditors: The audit of Satyam was down by PriceWaterhouse Coopers. Their report as of 17th August states believed the last results "give a true and fair view of the net profit and other financial information". It's now obvious they didn't even verify cash and bank balances - so were they in the know? Time will tell, but now every company audited by PWC is suspect.

Corp governance in general will be looked at carefully, so foreign money might fly out. I say "might" because there is much more fraud happening in the US and Europe, so one can't say for sure.

Lastly, the shares are likely to go to zero. This will cause payment issues at brokers who have them on margin or whose clients went long after that sudden 50% upmove.

In all the impact is negative, very negative. Unless there is some serious action taken in the next 24 to 48 hours, our markets are hosed. (I don't know what we can do, but the powers that are must know)

To the Board of Directors
Satyam Computer Services Ltd. Dear Board Members, It is with deep regret, at tremendous burden that I am carrying on my conscience, that I would like to bring the following facts to your notice:

1. The Balance Sheet carries as of September 30, 2008
   • Inflated (non-existent) cash and bank balances of Rs.5,040 crore (as against Rs. 5361 crore reflected in the books)
   • An accrued interest of Rs. 376 crore which is non-existent
   • An understated liability of Rs. 1,230 crore on account of funds arranged by me
   • An over stated debtors position of Rs. 490 crore (as against Rs. 2651 [cr.] reflected in the books)
2. For the September quarter (02) we reported a revenue of Rs.2,700 crore and an operating margin of Rs. 649 crore (24% Of revenues) as against the actual revenues of Rs. 2,112 crore and an actual operating margin of Rs. 61 Crore ( 3% of revenues). This has resulted in artificial, cash and bank balances going up by Rs. 588 crore in Q2 alone.

The gap in the Balance Sheet has arisen purely on account of inflated profits over a period of last several years (limited only to Satyam standalone, books of subsidiaries reflecting true performance). What started as a marginal gap between actual operating profit and the one reflected in the books of accounts continued to grow over the years. It has attained unmanageable proportions as the size of company operations grew significantly (annualized revenue run rate of Rs. 11,276 crore in the September quarter, 2008 and official reserves of Rs. 8,392 crore). The differential in the real profits and the one reflected in the books was further accentuated by the fact that the company had to carry additional resources and assets to justify higher level of operations — thereby significantly increasing the costs.

Every attempt made to eliminate the gap failed. As the promoters held a small percentage of equity, the concern was that poor performance would result in a take-over; thereby exposing the gap. It was like riding a tiger, not knowing how to get off without being eaten.

The aborted Maytas acquisition deal was the last attempt to fill the fictitious assets with real ones. Maytas’ investors were convinced that this is a good divestment opportunity and a strategic fit. Once Satyam’s problem was solved, it was hoped that Maytas’ payments can be delayed. But that was not to be. What followed in the last several days is common knowledge.

I would like the Board to know:

1. That neither myself, nor the Managing Director (including our spouses) sold any shares in the last eight years — excepting for a small proportion declared and sold for philanthropic purposes.

2. That in the last two years a net amount of Rs. 1,230 crore was arranged to Satyam (not reflected in the books of Satyam) to keep the operations going by resorting to pledging all the promoter shares and raising funds from known sources by giving all kinds of assurances (Statement enclosed, only to the members of the board). Significant dividend payments, acquisitions, capital expenditure to provide for growth did not help matters. Every attempt was made to keep the wheel moving and to ensure prompt payment of salaries to the associates. The last straw was the selling of most of the pledged share[s] by the lenders on account of margin triggers.

3. That neither me, nor the Managing Director took even one rupee/dollar from the company and have not benefitted in financial terms on account of the inflated results.

4. None of the board members, past or present, had any knowledge of the situation in which the company is placed. Even business leaders and senior executives in the company, such as, Ram Mynampati, Subu D, T.R. Anand, Keshab Panda, Virender Agarwal, A.S. Murthy, Han T, SV Krishnan, Vijay Prasad, Manish Mehta, Murali V. Sriram Papani, Kavale, Joe Lagioia, Ravindra Penumetsa, Jayaraman and Prabhakar Gupta are unaware of the real situation as against the books of accounts. None of my or Managing Director’s immediate or extended family members has any idea about these issues.

Having put these facts before you, I leave it to the wisdom of the board to take the matters forward. However, I am also taking the liberty to recommend the following steps:

1. A Task Force has been formed in the last few days to address the situation arising but of the failed Maytas acquisition attempt. This consists of some of the most accomplished leaders of Satyam; Subu D, T.R. Anand, Keshab Panda and Virender Agarwal , representing business functions; and A.S. Murthy, Han T and Murali V representing support functions. I suggest that Ram Mynampàti be made the Chairman of this Task Force to immediately address some of the operational matters on hand. Ram can also act as an interim CEO reporting to the board.

2. Merrill Lynch can be entrusted with the task of quickly exploring some Merger opportunities.

3. You may have a testatement of accounts’ prepared by the auditors in light of the facts that.I have placed before you.

I have promoted and have been associated with Satyam for well over twenty years now I have seen it grow from few people to 53,000 people, with 185 Fortune 500 companies as customers and operations in 66 countries. Satyam has established an excellent leadership and competency base at all levels. I sincerely apologize to all Satyamites and stakeholders, who have made Satyam a special organization, for the current situation. I am confident they will stand by the company in this hour of crisis.

In light of the above, I fervently appeal to the board to hold together to take some important steps Mr T R Prasad is well placed to mobilize support from the government at this crucial time. With the hope that members of the Task Force arid the financial advisor, Merrill Lynch (now Bank of America) will stand by the company at this crucial hour, I am marking copies of this statement to them as well.

Under the circumstances, I am tendering my resignation as the chairman of Satyam and shall continue in this position only till such time the current board is expanded. My continuance is just to ensure enhancement of the board over the next several days or as early as possible.

I am now prepared to subject myself tothe laws of theland and lace consequences thereof.

(B. Ramalinga Raju)
Copies marked to:
1. Chairman SEBI
2. Stock Exchanges

Update: Ramalinga Raju, the CEO, has resigned. He has sent a letter saying he cooked the books. DSP-Merrill Lynch, a firm retained for corp. governance, has terminated its association with the company.

This is horrendous. Horrendous. Stock down 50% now.

The holding of the Raju family in Satyam Computer Services Ltd fell to 3.64% after IL&FS Trust Co. Ltd informed the stock exchanges on Tuesday that it had sold 24.52 million of the firm’s shares that had been pledged with lenders

The stock, meanwhile, is at 186, a good 50% off it's lows of 120.

But DSP-ML has Raju's shares pledged to it and is looking to sell them to cover margin calls.

DSP-ML is everywhere! Kothari must be proud.