Satyam: Acquisition Raises Serious Questions About Governance and Strategy

Excerpts from Gilford Securities analyst Ashish R. Thadhani's recent note to clients on Satyam (SAY):

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Summary. Tuesday morning, Satyam announced that its board had approved the acquisition of privately-held Maytas Properties (100% for $1.3 billion) and BSE-listed Maytas Infra (51% for $0.3 billion). The transactions were expected to close in December 2008 and February 2009, respectively. Founded by family members of Chairman Raju (note Maytas = Satyam spelled backwards), the two companies are engaged in infrastructure construction and asset development with annualized revenue approximating $450 million (Properties = $90 million, Infra = $364 million) and an order book of $2.5 billion (excluding a major Hyderabad metro project).

Details. Faced with the current downturn, Satyam felt motivated to adopt a “game-changing” diversification strategy. It believes that this new/domestic segment can “mitigate risks associated with developed markets and traditional verticals that are likely to be impacted by the recessionary economy” … and stated that “even in developed regions, there is an attempt to use infrastructure as an economic stimulus to kickstart growth.”

Satyam simultaneously reiterated its aspiration to be a leading player in the global IT services business. On the morning conference call, management noted: familiarity with the infrastructure business, which pre-dates IT; the ability to address priority construction projects encompassing highways, bridges, metro/railways, ports, airports, power generation, irrigation, townships, SEZs, hotels and retail space; the opinion of an unnamed “big-4” firm highlighting that Maytas Properties has 33% of the developable space compared with industry-leader DLF but only 11% of its valuation; an implied 10% net margin for the combined Infrastructure business (one-half of IT) and likely EPS dilution in the first year (about 15% according to our preliminary calculations); and as much as a 50% contribution to total revenue within five years.

Conclusion. SAY shares sold off 55% on the news due to deep concerns: depletion of Satyam cash ($1.0 billion or $2.95 per ADS as of September) to acquire entities that are ~35%-owned by the Chairman’s immediate family – without a shareholder vote; abrupt entry into an unrelated, capital intensive business during a challenging time (Maytas Infra shares have dropped 47% in 2008); implicit lack of growth opportunities within the IT services business; and negative financial implications, i.e., near-term EPS dilution and longer-term P/E erosion. After the close, in deference to shareholder feedback, Satyam reversed its decision. We are revising our 12-month target price from $22 to $14.50 – or 10x forward EPS (from 15x).

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SAY shares are suitable for aggressive investors. In our opinion, principal risks include the following: U.S. slowdown; rising offshore salaries; appreciation of the Indian currency, which would translate into higher expenses incurred in rupees; correction in the Bombay Stock Exchange and/or U.S. markets; political opposition in the U.S.; and geopolitical uncertainty in the Indian subcontinent.

Comments

[E Nuff Sed:]

Looks like a bunch of crooks are running the company for their own benefit. Would'nt touch it with a 10 foot pole.

2008 Dec 24 10:59 PM