Deepak Shenoy

Three Investor Lessons from the Satyam Scandal

If I conveyed the impression that I thought Indian companies were "safe" - I apologise. That was not the intention. My point was that Satyam was a case of fraud - it doesn't happen in India regularly, just like you don't get an Enron everyday. (Maybe right now, when they come out the woodwork..)

This is really not about American investors knowing India or not - even if they did, like many Indians do, Satyam would be a dramatic surprise.

But in general, yes, one needs to know about Indian laws, that we allow our companies to defer tax reporting till the last quarter, that we let companies take non-hedged forex losses on a balance sheet (and then not report balance sheets), that our insider trading laws have very lax enforcement etc. And I learn about American laws everyday - how companies can buy back shares when they continue to throw out options or share sales, how mark-to-market can be thrown out the door for a while, how naked short selling continues to be unregulated etc.

Even enforcement is different: Madoff does away with $50 bn and is out on bail, while Raju does $1.2 bn and is in jail (bail was refused). In other cases, it might be the exact opposite (heck, Raju might never get convicted!)

Having said that we all get the frauds, some blatant and some subtle.

Three Investor Lessons from the Satyam Scandal

This is rich. That SAY's scandal was "simple" and Enron, Worldcom or Tyco "complex" is beyond believable. When it did come out, Enron's scam seemed simple; after all, what they did was funnel money to Fastow's company, and hide the real risk. Sure some of it was in financial statements; but that was just the tip of the iceberg, and only helpful insiders cracked it for us.

Tyco's scandal was probably the closest. Mangement pilfered cash, and they overstated cash flow.

Satyam's hiding of the cash flow through "creative" measures is probably going to turn out to be complex as well, later. And this kind of fraud, it will be found, is likely to happen in the US as well.

Having said that the disclosure norms in India are not exhaustive or specific enough, and companies still need not disclose balance sheets and cash flow statements at the end of each quarter. While the US SOX is nowhere close to successful, but we definitely need more rigorous norms, peer audits, and verification procedures in India.

But the thing is: Such frauds will happen all over the world. After this bank rescue moral hazard, it will only get worse; we've seen excesses already in AIG, and we're likely to see more conventional filching by the newly crowned "bank holding companies", which by definition includes everyone except you and me.

I wouldn't adopt a holier-than-thou attitude on regulation; definitely nt after the recent past. That there is a problem is accepted, that there won't be a similar one in the US is just laughable. Though if anything I must admire the massive amount of reliable data available in the US on everything not in corp balance sheets - CDS prices, real estate, construction, jobs, and even architectural billing! At least that gives you a way to assess an industry.

Three Investor Lessons from the Satyam Scandal

This is rich. That SAY's scandal was "simple" and Enron, Worldcom or Tyco "complex" is beyond believable. When it did come out, Enron's scam seemed simple; after all, what they did was funnel money to Fastow's company, and hide the real risk. Sure some of it was in financial statements; but that was just the tip of the iceberg, and only helpful insiders cracked it for us.

Tyco's scandal was probably the closest. Mangement pilfered cash, and they overstated cash flow.

Satyam's hiding of the cash flow through "creative" measures is probably going to turn out to be complex as well, later. And this kind of fraud, it will be found, is likely to happen in the US as well.

Having said that the disclosure norms in India are not exhaustive or specific enough, and companies still need not disclose balance sheets and cash flow statements at the end of each quarter. While the US SOX is nowhere close to successful, but we definitely need more rigorous norms, peer audits, and verification procedures in India.

But the thing is: Such frauds will happen all over the world. After this bank rescue moral hazard, it will only get worse; we've seen excesses already in AIG, and we're likely to see more conventional filching by the newly crowned "bank holding companies", which by definition includes everyone except you and me.

I wouldn't adopt a holier-than-thou attitude on regulation; definitely nt after the recent past. That there is a problem is accepted, that there won't be a similar one in the US is just laughable. Though if anything I must admire the massive amount of reliable data available in the US on everything not in corp balance sheets - CDS prices, real estate, construction, jobs, and even architectural billing! At least that gives you a way to assess an industry.

Seeking Alpha in Indian Real Estate

Prices are already going down in India (though urban real estate and condos are hugely valued and people tend to pay huge premiums as compared to the US, even in a slump). Specifically, in Bangalore panic pricing is setting in. Even in Delhi and Mumbai prices have slowed down and there aren't too many transactions happening - both in commercial and residential real estate.

I'm in India and I can short them all - but I just don't think it's right to do it now. The national budget, usually a big important thing here, is up on the 29th and could contain sops for the sagging real estate sector, or for real estate investments in general. 29h is also the first day after the current month's futures expiry so if I had to short, I'd choose the end-of-day of the 29th to start.

How Much Longer Will Indian Outsourcers Offer Cost Advantages?

I'm in Bangalore where the "maximum" for 10 years of experience (equivalent to the 120,000 a year salary in say Northern California) is about 20-25 lakhs. (2-2.5million rupees) Your mileage may vary of course.

Also it's not just about quality. The time differences is a huge issue in my opinion. Secondly communication skills vary, and the best communicators (in India) demand and get far higher salaries. Thirdly, process management is great for the lower cost jobs, but innovation is more important for moving up the value chain. We have not yet demonstrated our prowess in that field, at least not in the outsourceable dimension, if there is such a thing.

I don't think you can outsource innovation unless you can outsource ownership as well. Innovation comes from the ability to benefit from the ends, not the means.

IMHO, what will happen is that eventually there will be balance sheet transfers. Meaning a division of a big company gets transferred over to Mr. Wipro or Mr. Infosys. This then generates future cash flow, and then the Indian company can choose to have American Employees, or Indian employees or use people in Mexico, Argentina or Philipines - makes no difference.

Now they're competing with HP, IBM and the like, which are a) more experienced in deal making, b) also have offices in India and other lower cost countries and c) have far bigger balance sheets and deal absorbing leverage.

From a stock perspective this means a hit to P&L upfront, dilutions or fund raising if necessary etc. If they go down this route (they have to, in my opinion) we will have to see how they pan out, since they haven't done this in any significant way earlier.

Another thing is to spend money on a product framework that could be cross-sold among customers. It needn't be a software product - those can't be cross-sold effectively - but could be things like TPA services or wholesale agency networks for insurers, deal syndication for banking (buy prosper.com!) and so on.

This is now an acquisition based process rather than the plain old gimme work and I'll do it. It's more like "We know your process well enough to take it over,manage it, give it to you for cheaper than you pay right now, and even use it to cross sell to others". Different ball game, different rules. We'll see how it pans out.

Which IT Outsourcing Company Gives Maximum Return on Covered Calls?

Actually, you would write an OTM (out of the money) naked put - not an in the money one. $55 put is already in the money to the tune of $4, and the real price of it should be around $9 ($6.5 looks suspiciously low)

For the covered call, you chose a $55 call, getting $3.5 on it. THat means at a spot (cash) price of $50.5, you are effectively getting the share for $47, which is your break even point on the downside. To get the same thing you should write a $50 put for $4 (meaning a BEP of $46) or a $47.5 put at $2.85, which is an (even lower) break even point of $45 or so. THe former is preferable if you are bullish since you get more commissions (which is the income) and the latter is a play-it-safe strategy. Essentially the put should be out of the money and the break even point should be around the same level as the covered call you would otherwise have written.

Coming to brokers that give this option: I am in India where all brokers allow you to write naked puts on Indian stocks or futures, margin requirements vary from 50% to 10% of (strikeprice x lot size). In the US many brokerages do not allow naked put selling - or if they do they ask you to put up 100% of (strikeprice x lot size). the 100% margin is lousy because then it increases your capital exposure needlessly; obviously you will plan to get out of the trade if it goes against you (same as with a covered call). Still it lets you pay brokerage only one way (for the option) which is cheaper than the covered call (buy trade plus the option). But there might be a few that allow a naked put option for a decent margin - you may have to check...

Which IT Outsourcing Company Gives Maximum Return on Covered Calls?

Perhaps you misunderstood - i talk about WRITING naked puts, not buying them.

Writing a Naked Put is exactly the same on the risk/return graph as a covered call, if you intend to square off at expiry. It's just that a covered call involves more commissions to the brokers, which is why it has always been promoted. If you plot the pay off diagram a naked put it's exactly the same as a covered call (premium as profit if the stock goes up, strike price minus premium is your break even.

When you write covered calls or naked puts, you should write them on stocks that you do not expect to move much. There are perhaps better stocks than Infy (and indeed the Indian IT pack) to use this strategy.

For the same $20,000 use $15,000 as margin and write a naked put instead. As I said, the payoff is exactly the same as a covered call, and you pay lower commissions. Even if you use the same amount at risk, writing a put is less time consuming since you need to track only one thing (the market price of the put).

Which IT Outsourcing Company Gives Maximum Return on Covered Calls?

Why not simply write a naked put on Infy, Jan 08, strike price 47.5 - you get $3 per share in premium = $300, and your break even is $45. If the stock moves up you can square off (price will be lower) and write a higher put, say $50. It requires far lower investment (just the margin, which is obviously lower than 100 shares x market price) and the pay off diagram is EXACTLY the same as a covered call. Same risk, lower investment, same $ returns = higher return percentages.