Ovum on Satyam accounting irregularities

UK: Recent corporate governance woes at Satyam have taken a further turn for the worse. The company’s CEO, Ramalinga Raju, resigned after admitting that there were massive irregularities in the company accounts. The impact on Satyam has already been enormous and threatens its continued existence.

A massive market impact

The impact on the Satyam share price was immediate, with over 75 percent knocked off the value of the company, bringing the Bombay Stock Exchange Sensitive Index down over 4 percent in a chain reaction. Volumes of Satyam stock traded during the day were enormous as investors bailed. The Indian technology market had already been weakened by a tough 2008, and the badly dented broader market sentiment is sure to impact adversely most other Indian IT services providers. It will potentially even make a dent in the wider international market.

In the short and medium term the hugely deflated valuation of Satyam is likely to make it vulnerable to takeover. Even before the news of these corporate governance issues there was open market speculation that Satyam was either looking to bulk up through acquisition or that it would be at the core of a merger with rivals of similar scale.

MindTree, HCL Technologies and Tech Mahindra have all been mentioned among the rumours, although the reality of this gossip is currently impossible to gauge. Just like the ‘Big Six’ in the UK became the ‘Big Four’, so the Indian ‘SWITCH’ may become the ‘WITCH’.

Those who bought into Satyam stock during trading yesterday are likely to be hoping for a takeover bid that will drive up the price again. However, it also possible that Satyam might find itself broken into pieces and the pieces sold off separately. The expected fraud enquiry could delay the inevitable but it is equally likely that it will accelerate things, with criminal investigators and forensic accountants working together to establish the real financial position, and working out what is in the best interests of the shareholders.

Corporate governance: changes and marketing

Corporate governance will have immediately returned to become a ‘top of mind’ topic for most executives, given the events at Satyam and the obvious question of whether these problems were unique to Satyam.

Corporate governance was already on the agenda for many IT companies. As the credit crunch continues and price pressure on contracts is increasing, suppliers were turning to less tangible elements to differentiate their propositions. Environmental credentials, the broader CSR contribution and excellence in corporate governance were all candidates that marketing departments would have used to squeeze out the maximum possible amount of differentiation.

Corporate governance is probably now a taboo theme for marketing to play with. It’s unfortunate for MindTree, for example, that its recent ICSI National Award for Excellence in Corporate Governance won’t gain it as much cache as it really should. Satyam itself was only awarded the Golden Peacock award for corporate governance by the World Council for Corporate Governance three months ago, making a laughing stock of such accolades. The upshot of Raju’s confession is that the ability to play the corporate governance card is much reduced for all players.

Corporate governance problems elsewhere, such as those at Enron, Worldcom, Global Crossing, Tyco, Polly Peck and Parmalat, have typically brought strengthened regulation and a tightening of the supervisory framework, resulting in legislation such as the Sarbanes-Oxley Act. Of course, the governance regime and associated legislative frameworks vary from country to country.

In this case, we will see the Indian government re-examining its corporate government framework, with changes being made to strengthen it or at least to ensure the existing frameworks are robustly implemented, after all, Satyam was already subject to substantial scrutiny through external auditors, strong independent directors on the board and other supervisory controls. Many will wonder whether their own controls are strong enough and whether they are sure that their companies are not hiding similar problems, although at a lesser scale.

The scale of the corporate governance hole here is difficult to overestimate. From a cash and balance sheet perspective, Raju’s letter to the board and the stock exchanges where Satyam is listed declared that the real cash and balance sheet was only 6 percent of the figure declared in September 2008. Margins were 3 percent rather than the 24 percent claimed, and revenues were 22 percent lower than the Rs 27 billion that was declared.

This is massive, Enronesque in scale!

The author is SVP IT Research at Ovum.