January 11, 2009

The Dot Con Cornered

Maybe from now on, we can look at company names for clues. Satyam, named after truth, it turns out was just conjuring for us some fanciful numbers every quarter for years now, trying to pass it off for the truth. In a recent, though relatively tame, ponzi scam in Kerala, the perpetrator, a 21 year old lad called Sabari Nath, called his company ‘Total4you’. It was obviously intended to be ‘Total4me’ and ended up being ‘Total4noone’ when he ended up behind bars. You will remember that the big bull of the last decade, Harshad Mehta, called his company GrowMore Research and Asset Management Company Ltd. It grew in infamy.

Not that it is going to help us in reality. Not that we have much of a choice either. If Satyam can happen to us, then God bless us poor investors. Mind you, we are not talking about a fly-by-night company floated by a cunning entrepreneur looking to make a fast buck. No, B.Ramalinga Raju was one of the celebrated faces of the Indian IT industry. Why, a few years ago, the Financial Post, a Canadian publication, suggested that he might be feared in America even more than Osama Bin Laden for the potential threat his business was to the jobs of American citizens.

And why did he do it? Raju was not a Bernard Madoff whose very intention was to defraud the hand that fed him. Atleast, I believe he wasn’t. His undoing was in his willingness to resort to exaggeration in his company’s financials in his eagerness to assure the financial world that all was well with his company. The mild exaggeration, which everyone suspects happens anyway in corporate window-dressing, became acute when just to keep up the fa├žade he had to consistently overstate his profits, ending up with a little less than Rs.7000 crores of fictitious assets. Of course, that gap was intended to be rectified soon. Only thing his business never improved sufficiently to allow him the leeway to do so. In the end his predicament could not be summed up better than he himself did in his confessional letter. “It was like riding a tiger, not knowing how to get off without being eaten”. He continued to ride, till he was thrown off by the tiger itself. The clout which helped him call the shots so far finally deserted him. You can say he was cornered by his misdeeds. So let us examine them.

The first straw was the aborted move in December to acquire two other family owned companies, Maytas Constructions and Maytas Properties, a deal that was at that time unanimously approved by Satyam’s ‘independent’ directors. An uprising of shareholder activism on an unprecedented scale, coupled with the media frenzy put paid to that idea and the deal was called off within the day. Realty companies have been under the scanner for some time now. With liquidity drying up, property prices plummeting and just about everybody predicting doom for the sector, it was but natural that its promoter come up with ideas to bail out the twosome. No one, not even one soul, guessed that it was the parent company that needed bailing out. After all, wasn’t it supposed to be sitting on upwards of 5000 crore’s of rupees in cash? It was unimaginable that the whole exercise was designed so as to give some amount of credence to its Balance Sheet that was attaining humungous proportions in pretension.

When sorrows come, they come not as single spies, but in battalions. Or so Shakespeare mused centuries ago. The next straw was the World Bank ban on outsourcing to the company in a totally unrelated matter, pertaining to briberies made to bank employee’s years ago. While it might not have actually contributed to the revelations of this week, it sure did contribute to the notoriety of the management in the eyes of the public.

And then came the takeover rumours. Having all but forfeited investor trust, it was but inevitable that they be seen as exploring strategic options to enhance value. Merrill Lynch, the firm appointed to advise the company in this regard, would have refused to fall in line with the management’s intention of covering up its own tracks, and when they served their notice of termination of engagement citing irregularities, Ramalinga Raju and his partner in crime, his brother Rama Raju, was left to face the music.

The frightening part is that had one of these elements actually blinked, either the company’s investors or the media that whipped up a fuss, or Merrill Lynch at the time of Due Diligence, (Remember, PriceWaterhouse Coopers, the biggest of the big 4 of accounting firms was hoodwinked into not verifying some 5000 crores worth of bank balance for God knows how long) we might never have even known. But the tiger would not be tamed this time.

Mr Raju is probably consoling his family that he finally did come clean about the whole episode. That he tried his best to steer the ship like a man and only gave up when it became totally out of hand. Maybe he’s patting himself in the back for not defecting or killing himself, a route many other failed entrepreneurs have taken. He seemed to have been doing us all a favour with his generous gesture of submitting to ‘the law of the land’. But wait, who is he kidding?

Two years ago, in February 2007, his company unceremoniously sacked about 1000 employees overnight. The charge – Fake CVs and documents used to gain entry. While that indeed was a crime, doesn’t that pale in comparison with appearing on national television every three months to announce and answer questions relating to another quarter of sterling results that were simply fabricated? If faking was a crime what is his defence for waxing eloquent about corporate governance history and Golden peacocks to assure his own employees knowing full well that his covert actions were anything but straightforward? Or is ‘ethics’ and ‘honesty’ no more than rhetoric to keep cynics at bay?

Maybe some of you would hail him as a warrior who fought till the end. But to me, Ramalinga Raju is just a fraudster!

By the time you would read this, you would have heard various hypotheses in the news about the extent and methods of this scam. So, first of all, I must say that this was written when the scam originally broke out, using the first facts available and my primary reading of the episode. Regarding the stories that I’v been reading in the papers, some are valid. But most of the theories are plain absurd. But let me explain why I think so.

Take for example the accusation that a whole lot of people in the management would surely have known about it. But take my word, if even a few more actually did, we wouldn’t have had this scam. There are two reasons I bring in support of my point.
One, even though the nature of fraud was serious, the items are covered are not. All it takes to repress cash balance would be a banker’s tacit misrepresentation and the bribery/bullying of the auditor in charge. Its easier because cash being the easiest item to verify, the junior most staff are assigned by the auditor to verify the same. And 22 year old kids can be easily hoodwinked. Secondly, the involvement of directors needs to be analysed. Typically the accounts are finalised by the audit committee, (consisting of financially literate members of the board and the different auditors, and the committee would really not take it upon them to verify the veracity of cash balance. I mean, it’s the easiest thing to accept, an audited bank balance number) The audit committee the forwards the recommendations to the Board of Directors who usually pass it without much ado, considering that it has already been analysed.

Even more ridiculous is the suggestion that the company could not have been working on a margin of 3% (thereby implying that the management siphoned out money). While it is a possibility, it is still not prima facie evidence. The reason is simple. All through the year, export based companies have been losing revenue to exchange rate fluctuations. Implying that a company could have done pretty well, but due to an adverse currency bet, they could have a major chunk of that shaved away. During March to September, the movement was so unexpected that a company with the wrong hedging strategy could have got knifed. In fact, just last September the very same journalists were speculating that a few mid sized IT companies might go out of business if the wild fluctuations persist. Of course, blame it on the pressures of sleaze reporting, but does it cost much to think before you put ink to paper?

About Raju’s claims that he never took a penny of the company’s money, here’s how you should read it. Let’s say you were a guest at someone’s home and used there telephone lavishly. While you say goodbye, would you just leave a message saying that ‘hey, I haven’t stolen any of your money, but Iv raked up quite a huge bill on your telephone, please pay it”. And while I don’t have the figures, My memory tells me that Ramalinga Raju and his brother were among the highest paid Indian managers. So basically he was paying himself all that when he didn’t have profits to show?

Finally, Udayan Mukherjee on CNBC TV18 was wondering aloud about the actually existence of Satyam’s 53000 employees. Well, no one has paraded them so as to be sure, but I would rather believe that they exist. The catch is in the fact that them employees themselves must have been a part of a window dressing exercise to tell the world that all was rosy. Like, I know a few fresher’s at Satyam. And virtually all of them have spent their first year surfing the net for lack of projects. Now Iv been crying hoarse about it for the last one year at my old office. Why all your new hirees spend their first year on the bench if your business was improving as per your claims? Either they changed the laws of probability, or something was fishy. Now we know why! And this is precisely why I believe that in spite of al the rhetoric, Satyam will have to retrench a good part of their employees. They don’t enough business to justify its workforce.

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