Satyam Fraud Raises Tough Questions About Owning Stock

Fascinating. Incriminating. Disappointing.

Satyam's CEO has written a mea culpa letter to the regulatory authorities indicating a fraud of epic proportions that included inflated cash balance, fake earnings and more. He said, the scheme reached "simply unmanageable proportions" and he was left in a position "like riding a tiger, not knowing how to get off without being eaten." CNBC referred to it as the "Indian Enron" on air today.

The Tiger Got Away
by zeeshan Nasir (creative commons)

This will cast a long shadow on not just Indian IT companies but on all Indian companies, and perhaps other emerging market companies in general.

The sad reality is that this company is not alone. I suspect worse frauds by other Indian companies in the "Tier-2" category. Even Tier 1 companies like Reliance, DLF and Unitech appear to have used tricks to inflate assets.

By way of example, a lot of companies in India bought land in villages (at very low prices) and as real estate value went up, they showed value of "land banks" as assets on their books. Reliance, the largest Indian company, earlier last year had an IPO for Reliance Power - a company with virtually no assets but plans to build several power plants. The Reliance Power IPO was a classic dot-com era style offering - there was very little there except a shell company with ambitions.

Expect to see more of this from India, and perhaps other places.

Glass Half Full

But all is not lost. On the positive side:

• This makes companies like Infosys and Wipro even more valuable. They are truly well managed and ethical compaines. For years, Wipro and Infosys have had to live with potholes and hostility from local governments because they refused to bribe local politicians.
• India has a process and regulatory system that while not perfect, still exists. I don't expect similar companies in China to do a mea culpa. It will be interesting to see how Indian regulatory bodies deal with this.

Finally, it was my fear of bubbles and inflated balance sheets that made me write this post on Indian Bubble - my most popular post ever. The myth of a billion consumers waiting to buy condos and mobile phones can be laid to rest for now. India is a huge economy for many opportunities but it has not repealed the laws of gravity - everything that goes up too fast must come down.

What would Warren Buffett do?

All these scandals from Enron to Madoff to Satyam (SAY) are making us investors feel like we live in Alice's Wonderland where it's hard to trust anything.

So, what would Buffett do? One can only learn from his writings and interviews. It seems like his method of relying on people and signing multi-billion dollar deals based on relationships, family history, etc. is a far more trustworthy system than relying on a gaggle of for-profit, near-term oriented auditors, advisors and all.

And from an investor perspective - the misalignment between shareholders and management keeps getting wider. I have often said that I prefer founder-owned and run companies because I trust them to do what's best for the long-term interest of the business. With Raju and Satyam, I have to question that assertion - it seems owner-manager-founder can also sink ships - although as he claims (and yet to be proven) he made little money from this as he hasn't sold his stake - in his letter he claims he has not sold any Satyam stock over several years.

A Few Rhetorical Questions:

• How do I know which companies to invest in given that managers and board members are for-hire and short-term oriented?
• How do I assess risk when everyone seems to be willing to lie for a fee?
• Am I better off with owning a Subway franchise (a common theme amongst first-generation immigrants) than investing in public companies? Are we going back to the days of tangible ownership of assets?
• Final Question: Are shares no different than CDOs in that they are no longer promises that can be fairly evaluated, valued or trusted? If we can't trust shares, is our modern economy built on a CDO-like bubble?

What do you think? I am curious.

Disclosure: None

Comments

[investor88:]

It's tough out there. Caveat emptor.

Jan 08 08:07 AM

[Zyx007:]

Just a note that Reliance Power (Anil Dirubhai Ambani group) is different from Reliance (Mukesh Ambani group) with the name being the only common thread. Governance standards vary.

Jan 08 08:31 AM

[Swami:]

The biggest problem I have with owning stocks is that stakeholders who are supposed to guard the interests of shareholders dont seem to have the drive to do so. In SAY's case, instituations have 60% of shares and promoter 8%. Why didnt the insitutions insist on returning the huge cash on the books back to shareholders if management didnt have any useful purpose for it. No wonder Raju thought he could do anything with it. Independent board directors are a big fraud. They say they have very little time to spend understanding the day to day working and yet like to be seen with the responsibility on overseeing the management independently. They are hardly independent, they are working for the management. This is like a democracy in which intelligent people dont bother to vote and then blame the system for producing criminals.

Jan 08 09:19 AM

[fireball:]

anshu
i hold some mte in anticipation of the upcoming 3g bid.
i have been watching ttm for over a year but have never bought.
any thoughts on these individual stocks?

Jan 08 11:01 AM

[fireball:]

oops. ttm is what i have been watching.

Jan 08 11:05 AM

[auto44:]

This lack of trust has a lot to do with the fear that has investors money sittting on the side lines collecting zero intrest. Sarbanes Oxley, the very expensive law that was suppose to ensure transparency, has been a bust which so far has had the effect of driving a lot of good foreign companies to volutarily delist themselves from the nyse. Why aren't all these thieves being prosocuted under this law.

Jan 08 10:09 PM

[Asatyam:]

The Satyam scandal represents the unholy nexus between politicians, business leaders and academia. Satyam never made it to the top three IT companies from India precisely because it has long been known to engage in unethical business practices. The final desperate act of buying Maytas, an infrastructure company that has no relevance to Stayam's core business, is nothing but an attempt to clean out what little cash existed in the company.

It is a shameful act of dishonest behavior on the part of Raju and his crony Board. As a person of Indian origin, I am ashamed of people like Raju and more importantly the Harvard-elite such as Krishna Palepu. As a fellow Hyderabadi, the pain is even more acute.

I think people like Raju and Palepu are making a serious dent to the Brand image of India and Harvard! I wonder whether Harvard's ethics committee is going to look at what Professors like Palepu are doing on the side!

Jan 11 12:36 PM