Monday, December 22, 2008

Satyam - Maytas Saga : Governance in Reverse Gear?

By any account, the Satyam-Maytas saga has been a bizarre episode of a blue sky vision for creating an integrated IT and infrastructure group collapsing into a muddled and messy strategic failure. It would be interesting to analyze what was wrong and right with the decision, and its quick reversal, and speculate on the future course of options.


Satyam Computers Services Limited (Satyam) founded by Mr B Ramalinga Raju in 1987 is India’s fourth largest information technology (IT) company with a turnover of US$2 billion. Maytas Infra and Maytas Properties are two companies of the Raju family, managed by his sons operating in the infrastructure and realty sectors. Maytas Infra is a public limited company with a turnover of $450 million while Maytas Properties is a privately held company with an estimated turnover of $90 million.

On December 16, 2008, in a stunning move, Satyam announced its decision to acquire the majority (51%) stake in Maytas infrastructure for $300 million and 100% stake in Maytas Properties for $1.1 billion by buying out the shareholding of the promoters i.e., the members of Mr Raju’s family. The $1.6 billion deal, if it had gone through would have consumed all the cash of $1.2 billion in Satyam’s books and even forced it to raise a debt of $400 million. From a quick look at the financials of the listed entities of the deal, the profitability of the combined entity would have slipped due to the current lower margins as well as the long gestation period and revenue volatility of future projects in the infrastructure and realty sectors.

Teasingly, Maytas is Satyam, with the letter string in reverse order. Satyam’s founders who were in construction business prior to setting up and growing the IT business, probably thought that information technology and infrastructure are two sides of the same coin and decided to re-enter the infrastructure business. Unfortunately for the Satyam Group, all of its investor community, media and public thought otherwise and a spontaneous uproar followed. The Satyam Group was accused of derailing corporate governance through a self-serving, opaque decision which would place a major part of $1.6 billion of Satyam’s free cash in the hands of Mr Raju’s sons and family associates through the buyout. With only around 9 per cent of the stake in Satyam being held by Mr Ramalinga Raju and associates, it was alleged that he had no right to fitter away the Company’s resources without a proper discussion with other major investors and without seeking shareholders’ approvals, that too at a time when companies are conserving cash for their core businesses. Satyam’s ADR, listed in NYSE, lost 53% in a free fall on December 16, 2008. A similar drubbing for Satyam stock was to follow the next day on the Indian bourses.

On the night of December 16, 2008, Mr Ramalinga Raju explained over the investor calls and on the TV networks that the acquisition move was a well thought-out decision that would de-risk the core IT business and enhance long term value to the shareholders. He said that the investors who reacted adversely would calm down once the facts got understood in a proper perspective. Yet, as the chorus of protests went up, Satyam hastily reversed its decision just a few hours later and called off the Maytas acquisition deal on December 17, 2008. Mr Raju said that the decision to abort the proposed deal was taken in deference to the wishes of the investor community. Thereafter the Company has been at pains to mend fences, promising not to diversify out of the IT business and hinting that the Company would take several investor-friendly measures, including share buyback, to shore up credibility and restore investor confidence.

Strategic Purpose

Any decision to integrate, diversify, merge or acquire in related or unrelated manner needs to be inspired by a strategic vision or purpose. In this case, the acquisition of Maytas appeared to have little strategic purpose when announced. Was it to diversify Satyam into a growth sector of India, which infrastructure probably is, or was it to simply create a conglomerate group? If it was to de-risk the IT business, is it reasonable to conclude that IT became strategically risky for Satyam? Per contra, is there any assurance in the era of global meltdown that infrastructure is any less risky? Apparently, there has been no synergistic vision or strategic purpose that would have brought out the rationale of Satyam seeking to acquire Maytas.

Granting for a moment that IT growth has slowed down or the IT business itself has turned risky, given the cash reserves it had, did Satyam truly and sincerely analyze all the options that could have been possible to de-risk the IT business? Various options could have existed; from a merger with or acquisition of another IT behemoth to acquisition of a domain specialist which could strengthen any or some of its verticals. Under the former route, being a predominantly services company, Satyam could have acquired a pure product company or a pure web and search business company. In the latter route, having specialized in verticals such as SAP, engineering or life sciences, it could have joined forces with a design-driven manufacturing firm or a research-driven pharmaceutical firm.

Again, granting for a moment that entry into infrastructure was the best option for Satyam to consider, did Satyam truly compile and evaluate all the infrastructural options that could exist? Would it be appropriate to acquire realty and construction oriented infrastructure companies such as Maytas Properties and Maytas Infra or to consider companies in other infrastructure sectors such as power equipment, engineering & construction competence or alternative energy? Again, it is not clear if such options were compiled and analyzed. Lastly, assuming that realty and construction management oriented Maytas was the best fit, how were valuations arrived at? Were there stand-alone and combined business plans, pre- and post-merger, which demonstrated a superior value that the merger would bring to all the parties to the deal? Silence on the front did indicate that no major analysis was carried out.

Process and Governance

The early thoughts of the proposed acquisition would have been seeded a few months ago but apparently the formal processes happened only over the last two weeks. The Board which comprised several reputed management and industry experts from India and abroad as independent directors did consider the issue without the interested directors being present. Yet, it is unclear if powerful arguments against the deal that are brought out here, and elsewhere in the media, were forecast by the board and balanced by equally powerful or more compelling arguments in favor of the acquisition decision. If so, Satyam should have gone to town with such logic rather than succumb to the adverse market reaction and reverse a decision that was claimed to be well thought-out and debated internally.

Transactions of this nature, especially between related parties required independent valuations of the target companies and an investment advisor (or multiple advisors) to make sure that the transaction was indeed an arm’s length transaction. Clearly, no investment banker of international repute was involved in the deal. Equally importantly the process of management analysis and decision making that preceded the sudden acquisition decision appeared to be deficient.

Given the low promoter holding and the related party nature of acquisition transaction, the founder-family and Satyam on one hand and Maytas Infra and Maytas Properties as the target companies on the other hand should have been extremely cautious in analyzing and pushing through the deal. Such transactions should be conceptualized and conducted, reflecting the adage on Caesar’s wife, in such a manner that the founder family is beyond any suspicion. Unfortunately in this case, governance matters appear to have been given the short shrift. Although the agreed upon valuations technically enabled the Company to move ahead with the acquisition without any regulatory or shareholder approvals, in spirit it was in violation of good governance practices. Given the related party nature of transaction, transparent and threadbare discussion of all issues, including business models of stand-alone and combined entities, valuation options, alternative deal structures, intended use of proceeds and future outlook would have been appropriate. Ideally, a committee of independent directors should have been constituted to make a thorough study of the proposed move and come up with multiple scenarios and a balanced professional judgment.

The justification in terms of de-risking the core IT business also brings to the fore the risk profile of Satyam’s IT business. If the management indeed believed that the core business had stalled it had a duty to incorporate this into its corporate guidance and unveil measures to address it with business strategies relevant to the IT field rather than disclose such slow-down as a justification for the contentious move.

In rescinding its decision as hastily as it has made, Satyam demonstrated little conviction in its own decision and little faith in its own wisdom. Panic in the wake of adverse investor reaction and the subsequent free fall in share price seem to have once again prompted expediency. An urgent consideration of share buy back proposal is now proposed to win back investor confidence. Here again, the assumption seems to be that investors can be placated by financial rewards which will mitigate concerns on governance. This assumption also appears contrary to good governance logic. Fundamentally, reassurances on the IT business model of Satyam, strategic options and measures to reinforce governance are called for rather than immediate shareholder rewards.

From knee-jerk response to strategic resolution

The controversy that has been generated over the Satyam-Maytas saga should not however limit one from analyzing the strategic implications and compulsions of an aspiring firm or a founder group in a professional and dispassionate manner. The fundamental issue is whether the founders of Satyam and the major investors would want Satyam to become a diversified conglomerate, in quest of which entry into infrastructure could be one of the components. If this proposition is accepted, the right company and the right deal with the right timing would become relevant. Though Satyam could theoretically select a non-Maytas option from among the various companies engaged in the infrastructure business, it is fair to assume that none of the established infrastructure leaders would be ready for a sell-out, dilution or even an alliance. Maytas Infra and Maytas Properties are cash strapped to execute projects, given the huge order book of $3billion (plus $4 billion of Metro Rail) and the land bank of 6700 acres that they respectively have on their hands. It is thus in the mutual interest of Satyam and Maytas to concur on the acquisition. The deal structure would follow as the next issue. The controversy related to the movement of the free cash from Satyam to the promoters’ hands through the Maytas buyout could be handled by bringing cash into Maytas Infra and Maytas Properties instead of using it to buy the promoters’ shareholdings. The entire deal would need to be analyzed and valued by independent accounting houses appointed by each of the three parties and the final proposals put through to the investors and shareholders.

If the investors and shareholders see value they would be happy to support such a proposal. For example, there could be significant operational synergy of deploying IT in infrastructure field, from project management to project operations. Satyam could create a new vertical for infrastructure in its core IT business to provide IT solutions in the infrastructure space to Maytas and beyond. Given that Maytas Infra has bagged major projects like Hyderabad Metro and Maytas Properties has pan-Indian property bank, the strong balance sheet of the combined entity could create an infrastructure business in a faster and more expensive manner than would have been normally feasible. Issues of corporate governance could be handled by keeping all the three companies separate and allowing them to function independently with separate boards and management teams. Governance would also be seen to be acted upon in both letter and spirit if the promoters connected with the three companies, Mr B Ramalinga Raju of Satyam, Mr Teja Raju of Maytas Infra and Mr B Rama Raju Jr of Maytas Properties ensure that the executive responsibilities are in the hands of independent professional managers.

The spirit of free thinking and the spirit of corporate governance are mutually reinforcing. The Satyam-Maytas saga has demonstrated how these two vital factors can be ignored by companies and founders only at their peril. Equally, the episode demonstrates to positive thinkers how purposeful vision, clear strategy and transparent governance could enable acceptable solutions for even the trickiest of problems.

Posted by Dr CB Rao on December 22, 2008



talking of synergising options you mention research driven pharmaceutical - that seems a bit jarring to the rest of the analysis.

cb@strategy said...

It was just an example. It could well have been automotive design or engineering design.