Who Will Benefit from Saytam's Failure?

Historically, the way you make money in times like these is that you find things where the fundamentals are unimpaired.

– Jim Rogers

That sounds easy enough, right? Just find unimpaired companies, buy them, and wait. In essence, there couldn’t be better advice right now. Of course, the question then is, “When should I buy unimpaired assets and businesses?”

For instance, Google (NASDAQ:GOOG) is going to be a mainstay on the Internet for years to come. Its market share is growing and its competition is fading. It is also making all the right moves during a downturn by cutting expenses, socking away cash (as much as $1 billion a quarter) and getting ready to deploy it when opportunities arise (there aren’t going to be any bailouts for dot-coms, so market share will go to the best companies, not the best-connected companies). It’s not senselessly buying back shares either to keep management’s stock options more valuable at the expense of the shareholders.

Google’s making all the right moves to thrive when the global economy does recover. The company is the very definition of unimpaired. Even though Google shares are off more than 60%, it still has a P/E of 18, pays no dividends, and is valued like a growth stock, which although still growing strong, will grow more slowly over the years. So, it’s reasonably valued, and maybe it’s a little cheaper than it should be or maybe a little too expensive, but it’s not extremely cheap or extremely expensive, which creates low-risk/high-reward trading and investing opportunities.

We’ve got to be looking for unimpaired assets at impaired prices.

The name of the game is buy low and sell high. Right now, there is an opportunity to buy low in the business process outsourcing (BPO) sector.

The Big Five Four in BPO

To be honest, I’ve hated BPO for years. BPO is when “non-core” activities like customer service or accounting for a business are outsourced. The masters of BPO are Indian companies, which provide basic business services at significantly lower costs.

Remember the other day when we resolved to ask ourselves, “Would I start this business today?” before buying any shares. Six months ago, the answer would have been a resounding “NO” when it came to BPO. It’s one of the worst businesses to be in. Workforces were large in order to create decent economies of scale. Costs (mainly employee salaries) increased at a double-digit rate for years as India’s economy was growing. Worst of all, anyone could get in the game. There was no moat. BPOs all provided very similar services and the only way to get more market share was to offer better prices. As a result, margins were pretty low and only getting lower.

India’s BPO was dominated by Satyam (NYSE:SAY), Cognizant (NASDAQ:CTSH), Infosys (NASDAQ:INFY), Wipro (NYSE:WIT), and Tata Consultancy Services (TCS – traded in India). They counted more than 40% of the Fortune 500 companies as customers.

There wasn’t much room for competition. They would battle it out for customers and undercut each other's prices just to get a contract. It was great for customers, but bad for all these businesses, but all that changed a few days ago.

The Enron of India

On January 12, Satyam reported it cooked the books to the tune of about $1 billion. It was never there to begin with. Satyam’s chairman (who is sitting in Indian prison right now) basically said it was all a ruse and it started out as something small and grew right along with the company.

It’s all over for Satyam now. After all, if you were a CFO at a Fortune 500 company why would you want to have a company, which is being touted as the “Enron of India” to manage your accounting?

It doesn’t make any sense. A few of Satyam’s customers already started to leave, including State Farm Insurance and other key customers could soon follow. Satyam has between $350 million and $500 million in contracts, which are up for renewal this year. That works out to between 15% and 20% of all revenue. Among the key customers who could be on their way out are Telstra (TLS), General Electric (GE), Qantas (QAN), and DuPont (DD). I’d be willing to bet there are plenty customers on their way out soon enough.

BPO: Zero Sum Game

Here’s the thing about BPOs, they’re just like any other commodity. When a company leaves one, it usually moves to a competitor.

In other words, what’s bad for Satyam is good for Wipro, Infosys, and TCS. They’re going to be handed market share in a business where you have to offer hefty discounts to lure customers away from competition. It’s a fantastic time to be in India’s BPO market…as long as you’re not Satyam. It’s already started to happen. In a recent interview, TCS’s COO, Mr. Chandrasekaran said:

We are not in talks with any of their clients actively. Are any of their clients calling us? They are calling us, definitely.

The Rebound in BPO

Here’s the thing. India’s BPO industry was rocked by scandal. Satyam has wiped away more than $5 billion in market value out of investors’ pockets. Satyam is clearly impaired. The rest of the BPO market is not. In fact, the rest of them will actually benefit from Satyam’s problems.

Despite the “good” news for Satyam competitors, investors haven't rewarded them, yet. Wipro shares are off 10% since Satyam’s announcement. Infosys and Cognizant shares are up 1% and down 5% respectively over the same time period.

It doesn’t make much sense. Imagine if Airbus announced an accounting fraud, half the orders for its planes were cancelled, and it could go into bankruptcy. What would that do to Boeing’s (NYSE:BA) business? Or if SAP (NYSE:SAP) was about to be brought down by a major scandal. What would happen to Oracle’s (ORCL) business?

The same thing, to a lesser extent, is happening in the BPO sector.

Any way you look at it, as we’ve been saying in our 100% Free e-Letter, the Prosperity Dispatch, India is going to be one of the best places to have your money over the next five, ten, and 50 years. The combination of a young population, a good (and getting better) education system, and a reasonably moderate political system, it’s probably one of the most unimpaired countries in the world. It’s just a matter of finding the right opportunities at the right times. Right now is likely one of those times – for India’s BPO industry at least.

Disclosure: None

Comments

[notsosmart:]

there could be fraud at the others.be careful.believe no one.

Jan 21 10:37 AM

[Hamilton:]

Andrew,
I think you've got the Satyam story wrong.

In my opinion, Raju stole the money, plain and simple. When you say "Satyam reported it cooked the books" you should really be saying "Raju claimed he cooked Satyam's books." Because that's all that happened. And you should also be aware that dishonest people lie, and their claims need to be examined thoroughly before they're accepted as fact.

I don't believe he cooked the books. Instead, his book cooking claim was a red herring used to throw investigators off his thieving scent. Inflating revenue in the manner he claimed would be very difficult to do given the nature of Satyam's business, its customers, and its auditors. The cash and revenue would be fairly simple to audit. Additionally, Satyam's financials as reported are not as unreasonable as Enron's were; they are perfectly in line with those of the competitors you recommend. So unless the competitors you are recommending are cooking the books as well, it is unlikely that Satyam ever was.

Raju did not cheat, instead, he stole.

He originally tried to steal by using Satyam's capital to purchase Matyas, his son's construction firm. When this failed, he stole the money, gave it to his family by siphoning it through his 300 companies, and pretended it wasn't there. And that's it.

I consider Satyam to be a solid, swiftly growing business, like many of the other BPOs you mention. The only difference is that Satyam had $1 billion stolen from it by its crooked former CEO. As a result, the future of the company is murky.

However, it is my opinion that the value of the company is more in line with what the market believed it to be 2 months ago than with what the market believes it is now, and it will not be the people who own Wipro and Infosys who benefit most, it will be the people who purchased Satyam stock during the panic.

Cheers,
Hamilton

Jan 21 04:03 PM

[Charlie Bottle:]

Hamilton,

Good thinking -i'm with you on that one in the sense I think that this is more about theft than accounting fraud/inflating the books. However in the current climate with lack of liquidity, ad an highly politicized environemtn not clear the company can actually recover. It is still a good risk/reward play though.

Jan 23 01:35 AM

[Raution:]

After the event everyone thinks he has the best skills to analysis. I fail to understand why is it that none of the corporate watch dogs even smell the slightest hint of the fiasco. This talks about our incababilities and inabailities to decode financials to core. I see few good points in the article as it talks about the next available opportunites rather than bitching about what has happened. It would be interesting to see who is benefitted the most out of the other big three.

Jan 23 12:33 PM

[Hamilton:]

There definitely are questions about whether the company can recover. As I see it, there are three significant risks with putting money in Satyam right now:

1) The re-stated financials may show that the company does not have much earnings power or is in poor financial condition
2) They can't find temporary funding to cover expenses
3) They lose a lot of their customers

My hypothesis is that the company's earnings and financial standing is not significantly different from what was reported earlier. This is the key, because if this picture starts to form, the funding will come and the customers will stay. It may be a while before re-stated financials are released, but I think insiders have a pretty good idea of what is left already.

Jan 23 04:16 PM

[Analysis Ca...:]

I disagree with Andrew's conclusion - "... what’s bad for Satyam is good for Wipro, Infosys, and TCS." Why is all of this not bad for others in the Indian BPO market and good for other BPO companies from emerging companies in Brazil, Indonesia, Russia, Singapore, ...? Does this incident not erode our faith in auditors of Indian companies in general? Was the wrinkle in PriceWaterhouseCooper'... (Satyam's auditor) stock price and damage to their reputation larger than Satyam's? Why shouldn't PwC implode rather than Satyam?

Jan 25 01:12 PM

[David Tsao:]

To add to Hamilton's comments, the company may not recover if they have a growing employee defection problem. Regarding Andrew's original post, you don't know what the increased scrutiny will reveal with respect to other business dealings outside Satyam.

There is enough ammunition for some customers take this incident, along with the the rash of terrorist incidents last year and look at other BPO vendors in other countries as Analysis Caution points out. Hence, best not to pull a quick trigger on WIT or INFY just yet.

Jan 25 10:58 PM

[Charlie Bottle:]

Hamilton, you're correct again. The historical earnings are probably correct, Satyam's profit margins are in line with competitors, the main accounting issue is the missing (i.e. stollen $1 Billion US). Satyam's profit margins are in line with competitors. No doubt the scandal has damaged the franchise but this was a 10 billion market cap company now trading at few hundered million. Given that the company does not have very large liabilities they ought to be still solvent provided they can meet their short term liquidity needs.

Feb 01 06:48 PM