Wednesday, January 7, 2009

India's Madoff? Satyam Scandal Rocks Outsourcing Industry

Indias Madoff? Satyam Scandal Rocks Outsourcing Industry

On the morning of Jan. 7, Ramalingam Raju, the chairman of troubled Indian IT outsourcing company Satyam Computer Services (SAY), sent a startling letter to his board and the Securities & Exchange Board of India. Raju acknowledged his culpability in hiding news that he had inflated the amount of cash on the balance sheet of India's fourth-largest IT company by nearly $1 billion, incurred a liability of $253 million on funds arranged by him personally, and overstated Satyam's September 2008 quarterly revenues by 76% and profits by 97%. After submitting his resignation, Raju ended his letter by apologizing for his inability to close what began as a "marginal gap between operating profits and the one reflected in the books of accounts" but grew unmanageable. "I am now prepared to subject myself to the laws of the land and face the consequences thereof," he wrote.

The letter shocked and angered corporate India, which has looked to IT executives as role models for a new breed of Indian entrepreneur. The benchmark Sensex stock index dropped 7.3% and Satyam shares fell nearly 78% on the day as investors fled in droves. Goldman Sachs (GS) suspended its recommendations on Satyam "because there is not currently a sufficient basis for determining an investment rating or price target for this company," Goldman analysts Julio Quinteros Jr. and Vincent Lin told investors. Earnings per share, warned JPMorgan (JPM) analysts in a report, "may be 70%-80% lower than reported numbers and consensus estimates for '09-'10." Satyam had become "India's Enron," said CLSA India analyst Bhavtosh Vajpayee, calling the case "an accounting fraud beyond imagination [and] an embarrassing and shocking episode in Indian corporate governance."

As executives at other Indian outsourcing companies nervously assess what impact the scandal will have on them, many industry observers now argue that the Satyam case will damage India's reputation as a reliable provider of IT services. Because of the Satyam scandal, they say, Indian rivals will come under greater scrutiny by regulators, investors, and customers. "The bubble is going to burst in terms of trust," says a fund manager in Hong Kong who has followed Satyam closely. Doubts about the reliability of Indian outsourcers are especially important, since customers often allow the Indian companies access to sensitive systems. "This industry doesn't just make widgets," the manager explains. "It's an intimate relationship." Certainly, says Gartner (IT) analyst Diptarup Chakraborti, "there will be caution in the short term, skepticism, and questioning." After all, "no one wants to do business with a known fraudster."

Investors Want Answers

Industry executives are desperately trying to contain the fallout. "The decline in governance and institutions represents a serious challenge to India," says Rajeev Chandrashekhar, president of the Federation of Indian Chambers of Commerce and Industry. Wipro Technologies (WIT) Chief Financial Officer Suresh Senapaty, went on TV to say that Satyam's actions should not infect the entire Indian IT industry. And Mohandas Pai, head of human resources at Infosys (INFY) and the company's former chief financial officer, argued Satyam's behavior is atypical. "We wish the regulators will investigate and punish the guilty," he says. "But this is not representative of our industry." John McCarthy, vice-president of Forrester Research, allays some fears. "I look at Satyam as an isolated case, and don't think the developments would have any impact upon India's No. 1 position as an offshore location."

Still, investors and clients are going to want answers. For instance, they're demanding to know how Satyam's auditor, PricewaterhouseCoopers, endorsed the company's accounts. "Auditors' complicity in what seems to be a multiyear misstatement of financials will also be explored," said CLSA's Vajpayee in his Jan. 7 report. Already, India's Registrar of Companies had begun a probe into a failed acquisition last month by Satyam of companies run by Raju's two sons. Now the country's securities regulator will add its weight by investigating the PwC audit. PwC issued a statement saying it was examining the issue.

Raju's confession is the latest in a rocky ride for Satyam, its shareholders, and its stakeholders over the past year. The company's clients include multinationals such as Nestl, General Motors (GM), and General Electric (GE). But in September, the World Bank banned Satyam from doing any of its work after it found Satyam employees had hacked into its system and gained access to sensitive information. It also did not renew their five-year contract. Satyam denied any wrongdoing. Then came a fresh blow on Dec. 16, when Raju announced the company would spend $1.6 billion to buy two infrastructure companies run by this sons, only to reverse the decision a few hours later under shareholder pressure. Satyam ADRs lost 50% of their value overnight. December also brought news of pending litigation by a former client, online mobile-payments service Upaid Systems, which filed a case of intellectual fraud and forgery against Satyam in 2007; a Texas court is scheduled to conduct a hearing on the case Jan. 7.

Tip of the Iceberg

In India, the Raju family's non-IT activities had already been viewed with some suspicion, in particular a free emergency ambulance service Raju began in Hyderabad, where Satyam is based. Last year, public-interest activists filed a petition challenging the lack of transparency and arbitrariness in the award of ambulance-services contracts in 12 Indian states—all of which had been awarded to Raju's operation. In November the Supreme Court of India questioned the contracts and demanded an explanation, which could result in the contracts being canceled.

With Satyam's management focused elsewhere, business suffered. Clients complained about lack of attention, and many professional managers began to leave.

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