Satyam's Scandal and Near Demise: One Year Later

It has been just over a year since the near demise of the company behind India’s largest corporate fraud, Satyam Computer Service (SAY), a company that at the time provided services to more than a third of Fortune 500 companies. A subscriber asked me about Satyam last week and wanted to find out if I would consider buying the stock. Given that it has been a year since the scandal broke out and the company has started reporting results once again, I figured I would take a closer look at the company.

In case you did not follow Satyam’s saga at the time, here is a timeline of the events that transpired:

• Dec 16, 2008: Satyam announces a plan to acquire Maytas Properties and Maytas Infrastructure, companies run by the sons of Satyam founder and chairman Ramalinga Raju that are completely unrelated to Satyam’s core software business. Angry investors react by punishing the American Depository Receipts (ADRs) on the NYSE with a 55% loss. The company scraps its acquisition plans in the face of investor backlash and announces the board is instead going to consider a stock buyback program.
• Dec 23, 2008: The stock drops 13.55% on the Bombay Stock Exchange on rumors that its founder and chairman Ramalinga Raju has resigned from the board. On the same day the World Bank confirms that Satyam was barred from doing all business with the bank for an eight month period last February following allegations of data theft.
• Jan 7, 2009: Satyam’s founder admits to falsifying accounts stating that the $1.04 billion in assets that the company listed on its balance sheet did not exist and that revenue was 20% lower than reported.
• Jan 10, 2009:Founder Ramalinga Raju is arrested and sent to prison awaiting trial.
• Jan 12, 2009: The stock plunges to $1.46 on the NYSE having closed the previous Friday at $9.35 per share. The stock is now down 95% from its 2008 high of $29.10 set less than 8 months ago on May 30, 2008.
• Apr 2009: Tech Mahindra eventually acquires a 43% stake in Satyam. Tech Mahindra is a subsidiary of Indian automobile company Mahindra & Mahindra, one of Tata Motors (TTM) key competitors and the company that battled Tata Motors to acquire Jaguar and Land Rover from Ford Motor (F).
• Jun 11, 2009: Satyam’s new chairman Kiran Karnik announces that the near-term revenue outlook was not great and that the company was under severe stress. The stock rises 10% for a third day in a row after results show that the company was still profitable. The NYSE listed ADRs open at $5.20 and hit an intraday high of $5.49 before closing the day at $4.30. The stock slides the rest of the month to end June at $3.11.
• Nov 13, 2009: Indian infrastructure firm Larsen & Toubro that held a 6.9% stake in the new entity, sold a third of its position for Rs 112.5 ($2.42, based on an exchange rate of $1 = Rs 46.5)
• Dec 3, 2009: JP Morgan (India) upgrades the stock from neutral to overweight with a price target of Rs 140 ($3.02 based on an exchange rate of $1 = Rs 46.31). JP Morgan analysts expect revenue to decline 36% in Fiscal 2010 (ended March 31, 2010), increase 18% in 2011 and 19% in 2012.
• Dec 9, 2009: Satyam settles a more than $1 billion patent dispute lawsuit with U.K based Upaid Systems for $70 million. The settlement gives Satyam a royalty-free license of Upaid’s patents. $265 million in lawsuits from 37 companies remain unresolved.

What is the stock actually worth?

Regarding JP Morgan’s forecast, since the Satyam ADRs represent two shares each, the equivalent price target for the US listed ADRs is $6.04, representing a 9.6% upside from the current price of $5.51. The litigation risk that Satyam continues to face combined with a tarnished image and lack of visibility should ideally support a valuation that is at a steep discount of at least 50% to its peers. The last time Satyam reported revenue under US GAAP was back in October 2008 when they reported revenue of $652.2 million. If revenue was indeed inflated 20%, let us assume actual revenue was $543.5 that quarter. Revenue most likely declined after the scandal broke out and at the time Tech Mahindra acquired a stake in Satyam, full year revenue was expected to be $1.3 billion. If Satyam does post $1.3 billion in revenue for fiscal 2010 ending in March 2010, based on its current market cap of $1.86 billion, the stock is trading at 1.43 sales.

With competitors like Wipro (WIT) and Cognizant (CTSH) trading at 5.63 and 4.38 times sales respectively, Satyam is indeed trading at a steep discount to its peers when you look at revenue. However Satyam’s operating margins were 3% when the scandal broke out while Wipro and Cognizant sport operating margins of 17.91% and 18.99% respectively. Unless Tech Mahindra can improve Satyam’s operating margins, which it most likely will, the steep discount appears to be justified. Assuming Satyam does post revenue of $1.3 billion, manages to improve its operating margins to Cognizant’s level, and we apply a 50% discount to Cognizant’s 4.38 times sales valuation, I get a market cap of $2.85 billion for Satyam, representing 53% upside for the stock from current levels provided you are willing you live with the risks, don’t mind the lack of visibility and are hopeful that these assumptions will bear out.

With the Indian economy expected to grow by 7 to 8% for the current fiscal year that ends in March 31, 2009 and a world bank real GDP growth forecast of 8% in 2010 and 8.5% in 2011, India is certainly a favored investment theme. Despite the fundamental reasons for buying into India and the cost cutting in developed countries that has fueled the rise of Indian software companies like Infosys, Wipro and Satyam, the industry does face a number of headwinds in the form of a weak dollar, rising salaries and increased competition from companies like IBM that have developed large operations in India. So along with company specific risk, you also have currency risk and industry risk to consider.

Overall it appears that Satyam might be worth considering as a highly speculative investment that may do well should conditions at the company improve in 2010 and beyond. If JP Morgan’s revenue forecasts for 2011 and 2012 bear out, the stock is a bargain at current levels.

Model Portfolio Update: I am going to close our position in mattress fabric and furniture upholstery maker Culp Inc (CFI) and book gains of approximately 93% in the InsideArbitrage model portfolio. The stock has performed well beyond my expectations since I wrote about it in the November 2009 investment newsletter and taking profits at this point would be prudent. The closing price tomorrow (Jan 13, 2010) will be used as the selling price.