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Satyam: A clear winner? - Outside View by Luke Verghese
 
 
Satyam: A clear winner?

The company is battling to re-establish its credentials and without any outside help too, and in part this is due to its past brand equity

Standing with its head held high

If matters do go the way that the current proprietors of Satyam Computers intend it to, then the company will be singing its swan song sooner than later as it gets absorbed into the orbit of its senior telecom software suitor Tech Mahindra. This is barring of-course the unlikely outcome of the googly that has recently been served in the courts by its original proprietors, and another creditor IL&FS Ltd, that the company owes them large dollops of dosh - and apparently need guarantees that their interests are not subverted by the proposed merger. The case is now being played out in the courts and there is no knowing how it will pan out at the end. The claims of the erstwhile promoters is big, real big at that-some Rs 12.3 bn, and it involves advances made to Satyam by 37 companies now claiming repayment of this sum, which was given as temporary advances. But in all likelihood this is only another roadblock in its march forward. The incumbent management is treating this claim with all the due respect that it can accord it, and the company has very thoughtfully acknowledged this sum while framing the balance sheet.

The annual report is made up of some 148 pages of verbose matter - but thankfully it is far less bulky than that of its predecessor and it comes with innumerable notes to the accounts which are baffling enough even to the initiated, but, not unexpected. The active resort to court hearings, the many cases which have been filed against the company and in turn filed by the company both within and outside the country, on the startling findings of the forensic accountants, on the provisions and write backs on assorted assets including advances that it has affected, the depreciation provided on assorted portfolio investments, the many ongoing battles with the income tax and sales tax authorities (the IT department seems intent on going after the company with a sledge hammer as if it is a pariah of sorts it seems, and the company in turn is busy moving the courts all around for succour), to the non compliance of the Foreign Exchange Management Act (FEMA) in respect of the non-repatriation of export proceeds and the consequences thereof, and the almost embarrassed 'without qualifying our opinion' remarks of the statutory auditor's - the list is about as long and as winding as the Great Wall of China.

The findings of the forensic accountants

The findings of the forensic accountants on the scamming of funds is sort of putting matters in the right perspective - the big problem here is that the government enforcement agencies have seized all the book of accounts of past years and are sparingly releasing them. The details as unearthed by these accountants include - fictitious cash and bank balances of Rs 9.96 bn, debtor balances of Rs 557 m, unrecorded loans of Rs 700 m resulting in an aggregate amount of Rs 11.2 bn, and leading to a net opening balance difference of Rs 11.2 bn. There are other transactions aggregating to Rs 166 m (net) arising from the set off of large sums of gross debits and gross credits, as also the inability of these accountants to identify the nature of transactions aggregating Rs 12.3 bn against which the company has received the legal notices. As stated earlier the company has very thoughtfully owned up for this sum in its balance sheet - in keeping with the guiles of the claimant.

The company has also made a provision in it books of Rs 5.2 bn towards income tax liabilities. But that provision hides the reality of the matter, which is a lot more complex. The auditor's report states that the company is fighting an income tax case involving a sum of Rs 6.2 bn in the Andhra Pradesh high court. This is shown in a schedule along with other direct and indirect taxes under dispute and is being contested. Separately, a note appended with the report adds that there is also income tax drafts notices of demand amounting to Rs 7.9 bn and Rs 10.7 bn respectively for two financial years issued by the Additional Commissioner of Income Tax against which the company has filed objections with the Dispute Resolution Panel. Tax cases involving the sarkar can take forever for an amicable solution. These then are some of the many crosses that the company has to carry in its current avatar.
But this is not to suggest that the company is vacillating between the devil and the deep sea. It has made considerable progress in cases filed offshore by foreign clients who claim to have been short-changed, and by investors seeking to file class actions suits against the company for losses on portfolio account. The urgency to settle these cases are paramount given the company's overdependence on its foreign operations to keep its head above water. By the company's own admission North America accounted for 50.5% and Europe another 24.5% of its total revenues of Rs 59.6 bn in 2011-12. This is how the moolah rolls in. Hence the dire need for the company to stand on its head to clear the firangi smog.

Moving ahead The company is indeed moving on judging from the financials that it has furnished. Flashing a winning smile, the chairman of the board Vineet Nayyar in his communique to the shareholders states that 'our journey of building the organisation continues and we have maintained the promising note with which we began our year...Stepping into the New Year we are confident of our way forward and are committed to delivering enhanced value to all our stakeholders'. Fully agreeing with this viewpoint the markets have rebooted the share price of the company in the secondary market to the three digit mark.

The revenue from operations moved up by almost 25% to Rs 59.6 bn in FY12. Export turnover amounted to a humungous 93.6% of the total revenues. In the preceding year it was marginally higher at 94.8%. Revenues generated in the domestic tariff area amounted for the balance income and includes a pitiable effort at exporting hardware. Isn't it some wonder also that India which is the third largest world economy (we have overtaken Japan) based on the PPP (purchase price parity) yardstick still accounts for a miniscule value of the software sold? (Besides, though the big five listed IT companies generate large export earnings; they also have to expend big sums in forex to generate those earnings. Satyam for example generated export earnings of Rs 55.8 bn during the year, but at the same time the forex outgo amounted to a humungous Rs 33.8 bn). So, in effect, the net forex value add is infinitely smaller. The 'other income' on its part also did full justice to its credentials by growing 37.5% to Rs 3.9 bn from Rs 2.8 bn previously. It may be noted here that other income accounted for 32.4% of the pre-tax profit for the year against a much larger 50% previously. The company's ability to grow its pre-tax profit thus rested on two major factors.

On the one hand employee handouts grew only 11% to Rs 36.3 bn. The company may however have to loosen its purse strings on this score sooner than later. Other income is made up of a hotch potch of receipts which cannot necessarily be counted on for an encore in the next year, given the many 'contingent' demands on the company. In the main the receipts consist of interest income on bank deposits of Rs 1.7 bn, gain on sale of current investments of Rs 407 m, gain on forex fluctuations of Rs 662 m, rental income from operating lease, and write-back of provisions amounting to Rs 633 m. Each of these heads of account is unique in its own way. It must however be noted that the pattern of earnings was roughly of the same proportion in the preceding year too, and that is a remarkable coincidence.

Resort to outsourcing

There appears to be an increasing resort to outsourcing to generate revenues. Subcontracting costs at Rs 4 bn (Rs 2.6 bn) amounted to 6.7% of the operating revenues against 5.5% previously. Some ten siblings were also beneficiaries of this sub-contracting moolah amounting to Rs 1.4 bn against Rs 803 m previously. Separately, there is a debit entry on account of 'software charges' amount to Rs 897 m, against a much smaller outgo of Rs 104 m previously. Does this entry pertain to outsourcing of software packages, perhaps?

Coming up trumps

But the company is really making a go of it, and coming up trumps in the process. It is debt free for one and hence interest costs are almost negligible - but that is partly because the liabilities provided for so far are merely book entries. (For example, there is the provision that it has made for class action settlements amounting to Rs 4.5 bn, or the enlarged provision of Rs 5.2 bn for backdated IT demands, or the provision for contingencies of Rs 3.3 bn. The tall claims of the erstwhile promoters, as stated earlier, are shown under a separate head in the liabilities side of the balance sheet, but it is more than matched by corresponding assets). It generated positive cash from operations to the tune of Rs 970 m during the year against a negative generation of Rs 1.7 bn previously. Trade debtors were well maintained at 22% of revenues --the same as previously, and the current assets minus the cash on hand of Rs 26.90 bn - was only marginally higher than the current liabilities at year end, implying a veritable fine tuning of working capital management. The cash on hand has been excluded from this working as cash is a fungible asset, and, besides, the company is also forced to set aside quite some cash resources on account of compulsory margin requirements towards obtaining bank guarantees. It must also be noted that the current assets include a sum of Rs 4.5 bn (against NIL previously) being amounts deposited as escrow for class action settlement consideration, but for which the net current asset figures may have been further fine tuned. So in reality, the company is generating a lot of cash. It also found the resources to spend Rs 2.6 bn on capital expenditure against a much lower spend of Rs 1.4 bn previously. Separately, it also indulges in buying and selling of liquid debt securities to generate some extra income. But in 2011-12 it cashed in on its holdings in securities to the tune of Rs 4.1 bn to fund its capex requirements, to pony up the escrow moneys, and in the further issue of capital in its subsidiaries and such like.

Investment in subsidiaries

And this brings us to its long term investments including mainly its subsidiaries. The gross value of its investments in its siblings' etc amounts to Rs 10.3 bn, but after provision for depreciation in the book value of the investments, the net book value figure stands at a mere Rs 1.7 bn. The investments in some eight siblings are fully provided for. This includes its largest investment of Rs 2.7 bn in Satyam BPO Ltd. For some reason it has during the year pumped in small sums of additional share capital into three siblings, Satyam Computers Shanghai, Bridge Strategy Group LLC, and Satyam Computer Services Belgium whose capital structure have been substantially eroded due to provisions. As a matter of fact the capital investment in Bridge Strategy was fully provided for. But, apparently, the company sees a spark of sorts emerging out of the rubble. It has also brought on board two new investments. As could be expected, the siblings generate no dividend income for the parent. But there are a number of inter-se dealings within the group. Its biggest investment, the BPO outfit, has a paid up capital of Rs 331 m and negative reserves of Rs 2.3 bn, but appears to be on the mend. On revenues of Rs 1.5 bn it registered a pre-tax profit of Rs 327 m. So the provisions made on the parent's investment can hopefully be written back to its P&L account at some point in time. Another big ticket outfit, Satyam Venture Engineering, on revenues of Rs 1.1 bn registered a pre-tax profit of Rs 98 m, but after a hefty tax provision, could only manage a loss of Rs 169 m. It appears to resorting to very poor tax planning, or something. The Belgium outfit in which it has just pumped in additional share capital ponied up a pre-tax loss of Rs 408 m, and after a tax provision of Rs 7 m, enlarged the loss to Rs 415 m. All this without rustling up a nickel in revenue that is! Wow; this is swell, and some way to go forward!

Bridge Strategy Group which also received an injection of capital during the year has negative reserves of Rs 417 m on a paid up capital of Rs 557 m. But on revenues of Rs 844 m it could only report a pre-tax loss of Rs 65 m. It would however appear that the parent sees a ray of hope here or some such. The other two big companies in revenue terms Citisoft Plc UK and US were both scraping the bottom of the barrel on the bottom-line front. It has collectively provided the brief financials of 15 siblings - seven of whom have reported pre-tax losses and three who boast of no revenues. Eleven of this lot is incorporated in foreign shores.

Seriously speaking, after reviewing the performance results of the siblings of Indian companies across the board, one is moved to think that such entities were germinated purely for the express purpose of providing some comic humour or some such. This is especially true of firangi siblings.

But, barring the nonchalant performance of these beauties, the company appears to be on song or some such.

Disclosure: Please note that I hold 900 shares in Satyam Computers

This column Cool Hand Luke is written by . Luke has been a business journalist, financial analyst and knowledge management head with a professional experience of more than 20 years. An avid watcher of the stock market, he has written extensively on stock market trends. His articles have featured in Business Standard, Financial Express and Fortune India amongst others. He has also been the Deputy Editor, Fortune India and the Financial Editor of The Business and Political Observer.

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