Raju steals $1.6 bn from Satyam - Why corporate fraud is an under estimated risk for Indian equities

Mr. Ramalinga Raju, hitherto esteemed Chairman and CEO of Satyam, today brazenly stole $1.6bn out of the company. Satyam, in which Mr. Raju owns a mere 8% (according to Bloomberg), decided to buy 100% stake in Maytas Properties for $1.3 billion, and $51% in Maytas Infra for $0.3billion, for a total outlay of $1.6 billion. Maytas Infra is a listed company in which Mr. Raju and family owns 36%. Maytas Properties, on the other hand is completely owned by Mr Raju. 

Satyam had about $1.2 billion cash as of Sep 30, 2008.  Effectively, that cash and a little more is being transferred to entities owned beneficially by Mr. Raju. This raises serious corporate governance issues for the following reasons:

a) Real estate has been in free fall in India since Jan 2008. Yet Satyam, which hitherto was doing IT outsourcing stuff, has suddenly decided to move into real estate and infrastructure. And to do this, it is not going through the organic route. It is taking the path of acquisitions. Specifically, acquisition of promoter controlled companies. 

b) The cash spent on acquiring promoter controlled companies is just a little bit higher than cash on books of Satyam. Is this a mere coincidence?

c) Satyam is listed on NYSE, publishes quarterly results that are filed with the SEC, and holds quarterly conference calls. Management meets regularly with investors. Yet, till last week, there was no indication from management that it is inclined to do its biggest acquisition and that too in a totally unrelated sector. Was there any discussion within the company or the board on this transaction? 

Or more likely, when Mr. Raju found his wholly owned company - Maytas Properties - in danger of defaulting of loans taken to purchase land at astronomically high prices in 2007, he unilaterally decided, as CEO and Chairman of Satyam, to use Satyam's cash balance to dig himself out of the hole? The board merely rubber stamped his decision. 

d) Is Satyam's board sleeping or what? Havent they looked at stocks of companies like DLF or Indiabulls Real Estate? The brazenness is shocking. 

One factor that investors in India have not paid adequate attention to is corporate governance. Promoters of almost 80% of Indian companies are corrupt. Historically, promoters used to steal money from companies by either making the companies fund their lavish lifestyles (like Vijay Mallaya) or simply have the company under-report numbers. Promoters kept the undeclared income - to enrich themselves as well to bribe all the beureaucrats, politicians and police officers. There is a big cash economy in India. 

In the past four years, as market multiples expanded and FII's and PE funds went crazy, India promoters found it more profitable to simply show this unaccounted for black income into the company's books. This resulted in a steep profit growth optically, high multiples on these suddenly high profit numbers and crazy valuations. Promoters got rich through the market route. Incidentally, this conversion of black income to white income and associated higher tax collection is what is behind the advance tax payments growth numbers that Indian media is so fond of tracking every pre-earnings season. 

A lot of promoters still leveraged themselves even more. Lending against stock was one of the most profitable business of brokerages till early this year. And now the promoters find themselves in trouble. Banks, brokerages and mutual funds are calling back their loans which the promoters cannot repay. Seems like a subsidiary of Maytas Properties has taken loans from HDFC mutual fund - we know HDFC has bailed out some of the FMPs (fixed maturity plans) of HDFC mutual fund because these FMP's had invested in suddenly illiquid commercial paper of certain real estate companies. The connection is complete. 

So what do you think the promoters will do? Will they honestly go bust and let someone else take their company away? Or, like Mr Raju, they are going to devise a scheme to use their company's money to bail themselves out? Will they again start stealing money out of their companies?  My belief is - an Indian promoter is unlikely to go bust in India because he/she is a crook of the highest order in 80% of the cases. Their role model - after all - is Mr. Mukesh Ambani.  Unitech's shareholders might go to 0, but its CEO wont go bust. He will simply sell Unitech's land to a 100% owned company at throw away valuations. 

Watch out for promoters with multiple companies and pressing funding needs: Zee-Dish, Reliance Power - RCOM etc. The list is long and the game is on.