update 9-Jan
When it rains, it pours ! for satyam it is pouring bad news.
I am reminded of buffett’s comment – There is never a single cockroach in the kitchen.

There are no suitors coming up. Who wants to be associated with a tainted brand ! The value of an IT company comes from three sources – its brand/ reputation, customer relationship and employees. The brand/ reputation is the foremost and a damage to this asset can destroy the other two.

Satyam, with a new board may be able to rebuild the company (though not to its former glory) partly. However the company is facing a cash crunch and if it is not able to get cash for operations, then it could be in serious trouble. Getting a loan is not going to be easy, if the books have been cooked and the banks cannot trust your accounts.

Once clients feel there is a risk, they may press the panic button too. It is not easy to change a vendor, but i will not be surprised if clients have not started working out a contigency plan.

Finally, this episode will impact Indian IT in the long run. Do you think clients will trust other companies as easily as they have in the past ? With Indian companies vying with IBM and the likes for billion dollar deals, trust and faith is far more important. This episode is going to make life diffcult for all the vendors.

A few days back, I wrote about corporate governance in Indian companies. I hardly expected this – a full fledged fraud at satyam. I was shocked to say the least. Satyam is not a fly by night operator. There were some concerns on the coporate governance (forget the peacock or whatever ‘bird’ award), but what has come out is not some corporate governance lapse, but outright cooking of the books.

Bad intentions
I personally have no idea of the intentions of the management. However from the letter and from what I have seen in the past on such incidents, is that the start of such a fraud is small and not with malice. The management typically is not able to meet the numbers and fudges the numbers a bit to meet the targets with the hope that they will be able to cover the gap in subsequent quarters. However the gap does not get covered and the management resorts to even more manipulation to meet the numbers till finally they hole is too big to cover. This happened with Enron, worldcom and several other companies during the dotcom bubble in the US.

Is satyam headed for bankruptcy ? I don’t think so. This is not a bank where there could be a run on the company. That said, there is more pain ahead and the critical thing to watch over the next few quarters would be how the company manages its customer relationships and employees, which are the bigger assets than the cash on the balance sheet.

Possible to know before hand ?
I received a comment on how to calculate the value of the company if the numbers cannot be trusted ? My response is – you cannot. The entire basis of investing is ‘trust’. When you invest your money in a company, you trust that the management is honest and presenting the true picture. You trust the auditors to be doing their job when they certify the accounts. Clearly both the management and the auditors blew it at satyam.

You can expect articles to come out on how it was evident that something was wrong at satyam. I would say that is complete bullshit. I have not analysed the satyam annual reports till date and plan to do so now to see if it was possible to know the fraud before hand. Most of the times there are red flags on aggressive accounting which would give you a clue that something is not right. You can use these red flags to stay away from the company. However it is very difficult to detect fraud from the public filings such as annual and quarterly reports.

What now?
Such incidents are not unique to India. They have happened in other countries around the world. What is different is the kind of punishment for such a fraud. In the US, the CEO of Enron was  sentenced to 24 years in jail. The US law is very strict with white collar crime and gives out harsh punishment for such crime.

In india, I doubt much will happen. We treat white collar crime as no crime. This incident is going to cast a major shadow on all indian companies. If satyam could fudge cash of 5000 crs+, what about all the smaller mid and micro cap companies which have some unknown auditors and a weak to non-existent board.

I hope investors now demand tranparency from companies and vote with their feet (sell !) if the management is not transparent.

Lesson for us
As an investor I can think of two ways to handle such an eventuality – avoid companies where corporate governance is suspect and diversify.

This is a complete tragedy, especially for the 53000+ employees who have worked for years with the company and now face this for no fault of theirs.

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