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The Tale of Two Companies

|Includes: Satyam Computer Services Ltd. (SAY)

This is about Satyam Saga. Most of the articles and comments I have read in business media focus on tangibles like revenue, profits, number of customers, etc. So in today’s post I am discussing my view of Satyam Saga. My focus is more on the intangible issues that are hidden and may not visible to common investor.

I would like begin with commending the authorities who made this transition smooth, swift, and without much ado. The use of word authorities here is a proxy for industry association, company law board, ministry officials, and other unknown institutions. I believe if this situation had prolonged and quick decisions were not made, Satyam would have went for a toss, and it would have had a negative impact on Indian outsourcing business. The short term implications would have been far reaching somewhat similar to Lehman Brothers.

One company is Tech Mahindra (NYSE:TM). The other one is not Satyam. My personal viewpoint about Satyam is that it does not have wide moat in the supply chain. It operates on a business model which uses labor arbitrage as its USP. It is relatively easy and manageable for customers to shift the vendor and still not have any significant impact on their operations. I do not have any intention to offend Satyam folks. However, one has to be pragmatic and take into account how their customer base (i.e. international companies across the developed world) views them as a company. It is viewed as Wal-Mart of software outsourcing industry. The second company I would like to include here is Larsen and Toubro (LnT).

In my view, LnT and Satyam do not jive together. Its initial attempt to increase the stake, now, appears to be corporate gamesmanship to have larger say in Satyam’s fate (and perhaps gobble it at a dime).

  • LnT is one of the few corporate houses in India that has institutionalized management. As opposed to a personality driven outsourcing business houses. Other than Infosys which outsourcing company is institutionalized? Infosys is also to an extent personality driven.
  • Satyam would have been a distraction for LnT’s management. Satyam’s business model and market segment works on a different business model. These two are opposing in nature and integrating the two would have been challenging and time consuming.
  • LnT’s business model is based on technological strength and execution expertise of large structural projects. LnT’s DNA is all about engineering, design, and construction project management in infrastructure domain. It does have few other business areas, but they are dwarfed in front of core business.
  • Early in 2000s, LnT made a strategic shift to focus only in the core strength. It got rid of cement and many other non-core businesses. Wasn’t there a plan to spin off LnT Infotech in its own entity? I fail to understand how buying Satyam would have helped its cause of focusing on core strength? or was there a strategy to combine LnT Infotech and Satyam before spinning them?

I believe this acquisition will propel Mahindra Group in India Inc’s big league and position itself into country’s top ten (or top five?) business conglomerate. However, I have mixed view about TM buying Satyam.

  • Time will tell if buying Satyam was cheap or expensive. The price that TM paid is for its customer base and employees. I believe it is very difficult to value an outsourcing company whose primary output is “knowledge support”. How would you put a value to algorithms that improves methods and process, reusable codes which anybody else could do it, knowledgeable of engineers who can leave at a drop off a hat, and customers who may shift easily?
  • The biggest challenge TM/Satyam will face is how it executes the integration process. A smaller company will have to learn to manage a much larger company.
  • Will the TM/Satyam management continue Satyam’s existing Wal-Mart model? or will it create any new competitiveness or any new value proposition remains to be seen.
  • Motivating the existing manpower will be another issue. With continued slow down in developed world, the manpower of combined company looks bloated. How will the new management rationalize this large employee base? The fact that TM has locked in key 100 employees shows that it acknowledges possible issues; otherwise what was the driving factor for this action.
  • In addition other myriad issues such as tainted reputation, class action suites, customer confidence, etc. are also in play.
  • The TM business segment and Satyam business segment are complementary in nature, and hence will not step on each other’s toes.
  • Mahindra group (and TM) is a personality driven management very similar to outsourcing business model. Therefore, overtime, it has higher probability of successful integration with TM.

I believe TM has quite a few challenges up its sleeve. However, TM buying Satyam is perhaps the only way for Satyam to survive.

What should a common shareholder do in this scenario?

  • If you are already a shareholder in LnT, then you may remain invested. Had LnT bought Satyam, I would have planned an exit strategy.
  • Satyam shareholders should plan for exit strategy. There are many other good low risk opportunities out there. Why would investors want to get sucked into this?
  • If you are already invested in Tech Mahindra, plan your strategy using asset allocation. If you still prefer to remain invested, then managing your allocation may help reduce risk. If possible take some profits, and allocate it to other opportunities.