Shooting in the Dark: How Much Is Satyam Worth?

Published: March 26, 2009 in India Knowledge@Wharton

A business magazine recently wrote a cover story about A.M. Naik, chairman and managing director of
the US$7 billion engineering conglomerate Larsen & Toubro (L&T). It was titled "The Great Gamble."
That's a curious phrase to associate with a solid company and a man who has been with the same
organization for the past 44 years and at its helm for nearly 10.

Naik's new sobriquet is courtesy of Satyam Computer Services, a company that has seen a massive fraud
orchestrated by founder and chairman B. Ramalinga Raju. When, in mid-December 2008, Satyam
announced a US$1.6 billion deal with sister company Maytas, the scrip plunged from Rs200 plus (around
US$4) to Rs150 (US$3), a 25% drop. In New York, the ADRs (American Depository Receipts) fell 54%.
Naik seems to have seen in this a buying opportunity. Through its investment vehicles, L&T bought 4% of
Satyam for around Rs140 (less than US$3) a share.

After that, L&T plunged even deeper. When the full dimensions of the Satyam scandal broke, and the
share fell to as low as 12 cents, L&T bought another 8%. Today, it holds 12% of the company and is one
of the major bidders vying for the beleaguered firm. But it is probably as clueless as any of the others on
the real state of affairs at Satyam. "The problem is that there are so many imponderables," says Ganesh
Natarajan, chairman of the National Association of Software and Service Companies (Nasscom) and CEO
of Zensar Technologies.

Another bidder -- Tech Mahindra, part of the US$6.7 billion Mahindra Group -- has also burned its
fingers through dabbling in the Satyam affair. Rating agency Fitch has withdrawn its coverage of the
company after it announced its bid. According to a Fitch statement, "Given the uncertainties regarding
the final closure of the (Satyam) transaction, the financing, and consequent financial impact on Tech
Mahindra, the agency is unable to take a rating action at the time of withdrawal."

L&T, Tech Mahindra and B.K. Modi's Spice Group have officially announced they are in the race. They
have put in expressions of interest (EoIs) as required by the government-appointed Satyam board. They
have also lined up the Rs1,500 crore (US$300 million) cash that the board has mandated that all bidders
show before they can proceed to the next round.
It is not known how many companies have submitted EoIs; no one else had declared themselves in the
fray at the time of writing. There are reported to be some multinational IT majors, private equity players
and domestic IT companies. It is unlikely that all will come out in the open given the de-rating of Tech
Mahindra and the hammering the L&T scrip has received on the stock markets. According to Calcutta-
based daily The Telegraph, "More than 60 entities were reported to have evinced interest after Satyam
kicked off the bidding process on March 9. However, the number dropped sharply when the bidders
were asked to submit detailed EoIs. An indication to this effect was available when Nasdaq-listed iGate
quit the race."

The iGate experience shows some of the difficulties in bidding for Satyam. "Initially, we were interested
in Satyam because we felt that it had a lot of good customers and good employees," explains Phaneesh
Murthy, CEO of iGate Corp. "Then, because the process was taking too long and, more importantly, we
were given to understand that we would not have any new financial information when the auction
happens we lost interest. Suddenly, a few days ago, we got a call saying that we would get more
financial information but the only way to get that was to put in a formal EoI."

Interest was reignited, but iGate backed out nevertheless. "While there is no one particular reason, it is
the totality of concerns like sliding revenues, unknown margins and large liabilities that made us pull out
of the race," Murthy told India Knowledge@Wharton after making the decision. "Through market
intelligence, we know that there are enough customer exits happening at Satyam. While the value
erosion and extent of liabilities were a concern, it was the totality of concerns that influenced our
decision. We did not go to the stage of getting formal financials from Satyam's board. However, we had
prepared our own model of financials and in that model it was difficult to get a reasonable return for
any investor. Our private equity fund partner had no role or influence in our decision to pull out."

Lots of Questions

Murthy's explanation contains all the questions that Satyam bidders, analysts and the media are asking.
In a nutshell:

* How do you value a company whose financials are unknown and whose chairman admits he has
been cooking the books for seven years?
 * Are there really good customers and good employees? How many have jumped ship and how many
more are planning to do so?

* Is the process taking too long?

* What about the huge liabilities that could arise out of the class action suits filed in the U.S.?

* Why are private equity players interested in this deal? Why are multinationals?

* Has the action of the regulators so far been adequate? Conversely, have they been bending over
backwards to save Satyam?

* Finally, do we need changes in laws to make future resolution of such situations easier? Does India
need an equivalent of Chapter 11 bankruptcy in the U.S.?

Opinions differ widely about possible answers to these questions. Consider valuation. The winner is
supposed to end up with a 51% stake in the company through a combination of new shares (31%) and
an open offer (21%) to ordinary shareholders. Satyam's current market capitalization at around 90 cents
a share is approximately US$600 million. This is the rationale for the US$300 million (the market value of
51%) the board has asked bidders to arrange as a pre-qualification for being allowed to bid. But is 90
cents a share a reasonable price? The stock had a 52-week high (pre-scam) of US$11. It dropped to as
low as 12 cents. How do you value such a company? What are bidders paying for?

"Satyam's strong client base and its large workforce," answers Ajay Garg, assistant professor of finance
and accounting at the Indian Institute of Management Lucknow (IIML). Adds Kishor Ostwal, managing
director of CNI Research, a Mumbai-based stock market analysis and data provider: "The buyer is still
getting business close to US$1 billion and, going by IT operating margins, he can earn US$100 million to
US$120 million a year. Even as some clients are leaving or contemplating leaving, if Satyam goes into
reputed hands with enough IT bandwidth, then retaining existing clients or scouting for new clients
should not be a problem. The buyer is just trying to leverage the business and the market cap at which
the business is available."
"Valuation models for IT services firms are heavily skewed towards the quality and quantity of their
human capital asset base," says Ravi Bapna, associate professor of information systems at the Carlson
School of Management and executive director of the Center for Information Technology and the
Networked Economy (CITNE) at the Hyderabad-based Indian School of Business. "Thus, Satyam's biggest
asset is its high-quality workforce, followed by its order book and related tacit knowledge about its
clients' business processes. I would count its physical infrastructure as a distant third, given oversupply
in the real estate sector. Unfortunately, post the debacle, the brand is more likely to be viewed as a
liability. Unlike physical assets, human capital is not subject to 'lock-in' and can easily be lured by a
potential suitor who does not want to take on the associated liabilities. While such a scenario should,
under normal circumstances, attract bargain-hunting type valuations, one can never underestimate the
hubris factor in the Indian context."

"While it is true that the Satyam name has been hit badly, and employee morale and customer interest
is very low, it is certainly not an organization that can be completely written off," says K. Raman, practice
head (telecom, media & technology) at the Tata Strategic Management Group (TSMG). "Bidders are
looking for an enterprise within which they can create large future value at an extremely attractive
valuation today. There is still a reasonably large client base intact within Satyam, new orders are being
booked and there are reasonably large acknowledged receivables that the company is looking to collect.
All this indicates that if the management falls in place, then one can probably have an entity which is
viable on its own going forward.

"Also, the way Satyam's business has been structured in the past may be of interest to certain types of
acquirers. For instance, Satyam has typically been more focused than its peers on package
implementation and ERP, which can be a good fit for an acquirer who is looking to scale. Similarly,
Satyam has a reasonably strong presence in the Indian market especially through its government
contracts. This can also be a good stream of revenues going forward."

"Customers are happy with the work that Satyam managers have done for them in terms of sheer
capability," says Natarajan of Nasscom. "A lot of mission-critical applications are being done and it is
always messy to migrate that to another provider. What the bidder will get is good employees and good
customer names. The bidder -- if he comes in quickly and has a credible management team which can
talk to employees and customers and show that the company is viable -- can convince them to stay on.
But the worry is that in a period of uncertainty, people will obviously not wait forever."

Rewards vs. Risks

The exodus has already begun. The Economic Times says that 3,500 of the 50,000 Satyam employees
have left in the past one month. But it also quotes chairman Kiran Karnik (who was roped in by the
government to rescue the company) as saying that this was normal attrition and no cause for alarm. The
Economic Times also reports that Satyam has lost 46 customers out of its roster of around 600. Those in
the process of migrating include Abu Dhabi Bank, Applied Materials, Emerson, Kansas State Bank,
Nissan, Sony, State Farm Insurance and Telstra. The Business Standard newspaper estimates current
revenues to be around US$1.4 billion to US$1.6 billion, against the US$2 billion plus pre-fraud estimates.
Ostwal of CNI puts it at a US$1 billion, and there are skeptics who say the figure could be whittled down
even further the longer it takes.

Could the sale process have been speeded up? "The bidding process is going just fine," says Natarajan of
Nasscom. "The board just has to get it done as soon as possible. They need to now set a final deadline.
Otherwise, it will be a continuing ping-pong battle. Given all the moving parts, the bidding process is as
good as it can get." Concurs Garg of IIML: "The government acted quickly when it dissolved the old
board and appointed fresh directors in a bid to stabilize the company and restore confidence."

Garg is doubtful, however, that equal alacrity has been shown in the case against the previous Satyam
management. "The legal case is taking a very long time," he says. "But that has always has been the
norm in India. A lot of frauds and crimes take place because the legal process takes too long to punish
the culprits." Adds Ostwal of CNI: "Although the media and others may think that the government and
the regulators have acted fast by reorganizing the board of Satyam, initiating the bidding process and
arresting the promoters, the fact remains that the case is mired in mystery. This leads one to believe
that, as in other cases of financial misdemeanors in the country, this time also the culprits will walk
free."

The continuing mystery, says Ostwal, has added to volatility of the Satyam share and given some bidders
too much leeway. "It has given enough room for speculation which has helped players in this stock," he
says. "It was on record that [L&T's] Naik had said that he knew more than minority shareholders in the
case of Satyam, which is against the spirit of the law. Normally, anybody bidding should have been asked
to maintain silence for at least a month before the bidding process -- as happens during IPOs (initial
public offerings). The varying nature of statements from regulators, the directors of Satyam and
interested bidders like [B.K.] Modi who tried to quantify the liabilities arising from the suits in the U.S.
have all led to increased volatility and price speculation by operators and people in the know."

Modi of Spice had questioned the market valuation of Satyam; he felt it was much too high. He also told
the media about a report from the group's legal advisors, Gibson, Dunn & Crutcher of the U.S., which
stated that the liabilities arising out of the class action lawsuits could range between US$440 million and
US$840 million. In addition, Satyam faces a forgery case filed by U.K.-based mobile solutions firm Upaid,
which comes up for a hearing in the U.S. in June 2009. The estimated liabilities of this case could be as
high as US$1.1 billion. These numbers far exceed Satyam's current market valuation of US$600 million.
"One can really never put a figure on class action suits and this also will get factored in the valuation of
the company," says Natarajan. "You should actually be paid to take Satyam," says an equity analyst who
does not wish to be quoted. Most research houses have now withdrawn their official coverage of
Satyam.

MNCs and Private Equity

Why are multinationals and private equity (PE) players interested in bidding? There is likely to be a
three-year lock-in for whoever wins the bid, so PE, in particular, seems an odd contender. "Typically, one
does not associate PE players with lock-in periods but, then, three years is really not too long," says
Raman of TSMG. "They do stay invested in companies for this period of time." Natarajan has a different
explanation. "PE players are probably fronting for larger multinationals," he says. "If PE players come in
by themselves and try to get in a team, it may not necessarily be good for the company. What Satyam
needs right now is not just money but also a strong management team and stability. There needs to be
an umbrella of credibility and trust."

This is something the multinationals could bring; the Indian IT firms, which are respected names
internationally, have declared they are not interested. "MNCs would get scale in India, [including]
capabilities and customers," says Natarajan. Explains Murthy of iGate: "It will give them a larger
footprint and employee base." Adds Ostwal of CNI: "Over the years, as margins in IT hardware and
peripherals decreased, big players like IBM and HP have been eyeing different revenue streams. In fact,
for IBM, IT services constitute an ever-increasing pie of its total revenues. Satyam would be a perfect fit
for IBM, which will give it capabilities and a skilled workforce. It can then leverage those along with its
brand to create a huge revenue source. HP, on the other hand, also stands to gain as it can then transfer
all its IT services' needs in-house to Satyam and slash costs as well as acquire a new revenue stream."
Raman of TSMG agrees. "While both HP and IBM have a large presence in India, they have also stated
their intentions of scaling this up further," he says.

New Rules of the Game

The Satyam bidding process has raised some questions that go beyond the company and the fraud its
promoter has perpetrated. In order to enable an easier salvage operation, the Securities & Exchange
Board of India (Sebi) has changed the rules of the game. For instance, the norm for pricing an open offer
is that it should be the average of the past 26 weeks, or two immediately preceding weeks prior to the
open offer, whichever is higher. The 26-week price, the higher of the two, is way above current levels.
"The floor price for the open offer would have been very high had the rules not been changed, and at
that price no bidder would have been attracted," says Garg of IIML. The rule has now been relaxed and
the buyer can make the open offer at the same price at which he is issued the new shares. There have
been other relaxations to allow the bidding to progress smoothly.

This has been by and large welcomed, particularly as it will apply to similar cases in the future. "The
changes made by Sebi are absolutely warranted," says Murthy of iGate. "Otherwise, in such cases, no
one can step forward to rescue the company." Ostwal of CNI disagrees. "SOS changes by Sebi are not
really warranted," he says. "In fact, it has become a habit with the regulator to make changes on an SOS
basis. First were the Promissory Note rules, then the disclosure of pledged shares, and then the Sebi
Acquisitions and Takeover guidelines." In his view, some foresight would have made such fire-fighting
unnecessary.

What is necessary -- and not just for Satyam-type cases -- is a bankruptcy law like Chapter 11 in the U.S.
"I am convinced that India needs a bankruptcy law," says Murthy of iGate. "It does help so many
companies to restructure themselves and return. The entire airline industry in the U.S., at some point,
has been in bankruptcy. They would not have been able to survive if it had not been for the bankruptcy
protection that they enjoy. The asbestos litigation in the U.S. would have killed many companies. But
they were able to reorganize themselves under Chapter 11 and come back." Says Natarajan: "We
definitely need a bankruptcy law. In fact, the strength of Silicon Valley is that if a company fails, it is
allowed to fail fast. Here, shutting down the company or restructuring it financially is quite a problem.
India certainly needs to look at the American bankruptcy law and try and create something like that."

Ostwal of CNI disagrees. "India does not require bankruptcy laws at the moment," he says. "India is still
an immature market going by the way in which markets and regulators are functioning. Ahead of
bankruptcy laws, we require physical settlement in derivatives, we require scrapping of creeping
(acquisition of shares by promoters) limits of 5%, we require the 15% acquisition and takeover limits to
be raised to 25% and, overall, we require a fair climate for hostile takeovers."
That's a prescription for the future. For today, everyone is keeping their fingers crossed that things get
sorted out soon at Satyam. As Murthy of iGate notes: "The longer it takes, the higher will be the erosion
in asset value."

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Here's what you think...

Total Comments: 3

#1 Satyam Sale Process

The problem with this overheated situation is that too many players threw their hat into the ring for the
publicity rather than with any serious intent. We have a wise board consisting of pros like Kiran Karnik
and Deepak Parekh and now we should leave it to them to separate the wheat from the chaff and get
the company into the right hands.

By: Ganesh Natarajan, CEO - Zensar & Chairman - NASSCOM

Sent: 12:18 AM Fri Mar.27.2009 - AU

#2 Satyam Valuation

Nothing to get worried about. It's a going firm with a strong tech background and enduring engagement
with Fortune 500 firms. At the present share price and the relaxations SEBI & CLB have given, Satyam at
any price is a song. See more at http://bit.ly/MMn8

By: Sukumar Sreenivasan,

Sent: 03:30 AM Sat Mar.28.2009 - IN

#3 How Much Is Satyam Worth?

Satyam has thrown up a number of important issues. The most dramatic one is that relating to the role
of independent directors. The other is over family group companies and their management. There is also
that regarding pledging of shares by companies to get loans. The disclosures seem to have opened up a
can of worms about the affairs of Bombay Inc. The most important is about the manner the GOI and the
Ministry of Corporate Affairs are handling the revival plan.

In the normal course, if the company had been small and the sector less visible, Satyam would have
been allowed to collapse and the management prosecuted for fraud, etc. Sadly, it is an Indian version of
"too big to fall."
Though a new management consisting of reputed persons from the IT and banking sectors has been
appointed, the hand that moves is that of the Ministry of Corporate Affairs. It is clear the new team is
not being given a free hand. In the context of elections to the Andhra Pradesh Assembly and the Indian
Parliament, the issue is eminently political.

At one level, the government does not want around 50,000 people to lose jobs. At another are the much
touted infrastructure projects like the Hyderabad Metro.

The government and new management have been taking unrealistic postures. They are unwilling to
disclose the names of bidders. And yet they say the process is transparent. To bidders, they will not
disclose the full financial picture of the company such as its assets and liabilities. They are unwilling even
to give details of "class actions suits" pending in U.S. courts. Though care has been taken to amend SEBI
rules to speed up the process, these will not help unless the bidder gets adequate information to justify
large value investments involved. Surely, they are not in a casino, and government cannot expect any
investor to gamble with his money. Even private-equity companies will not indulge in this game in the
current crisis situation. In any case, they are in hiding now.

No wonder iGate has withdrawn. There is the news item today that Modis has thrown the sponge.

Though formal attempts have been made to show that the process is transparent, there are more clouds
over it. The appointment of two foreign agencies who had not covered themselves with glory in Wall
Street does not lend credibility. The retired chief justice will find it difficult to find his way out of the
imbroglio created along his way.

Given the messy situation, the most pragmatic course would have been for the new management to
negotiate the sale with one party, preferably an Indian group, and sell the company. In an election year,
this option is not open to the GOI. So the revival process will linger longer and be the legacy to the
successor government. By then, Satyam would have witnessed further erosion in value, and the buyer, if
any, may be taking over a rump.

By: Kandaswami Subramanian, Not employed

Sent: 06:45 AM Sat Mar.28.2009 - AU