Fraud at Satyam drags down Sensex

The Satyam saga continues with the company's chairman and managing director resigning over accounting fraud. Satyam's shares lose almost 80% and drag down the overall market.
Satyam Computers' chairman Ramalinga Raju and managing director B Rama Raju yesterday tendered their resignations, taking responsibility for accounting fraud at the firm. According to a letter to Satyam shareholders that was sent to the Bombay Stock Exchange, the fraud pertains to both balance sheet entries and profit and loss items. The revelation caused the stock to drop 78% in one trading session and turned sentiment in Indian stockmarkets bearish.

The scale of the accounting fraud is huge. As of September 30, the most recent six-month accounting period, the Satyam balance sheet carries inflated (non-existent) cash and bank balances of Rs50.4 billion ($1 billion) (as against Rs53.6 billion reflected in the books), accrued interest of Rs3.8 billion which is non-existent and an understated liability of Rs12.3 billion.

SatyamÆs second quarter revenues and profits were significantly overstated. Actual revenues of Rs21 billion were 28% lower than the Rs27 billion declared and the actual operating margin was only 3% as compared to 24% declared by Satyam.

In the letter to shareholders, chairman Raju wrote: ôThe gap in the balance sheet has arisen purely on account of inflated profits over a period of several years. What started as a marginal gap between actual operating profit and the one reflected in the books of accounts continued to grow over the attained unmanageable proportions.ö Raju goes on to say that as the gap widened the founders got concerned that if it were to be disclosed the firm would become a takeover target, adding ôit was like riding a tiger, not knowing how to get off without being eatenö.

In mid-December, Satyam, which is one of India's leading information technology majors, announced a board-endorsed decision to buy Maytas Infrastructure and Maytas Properties, two closely held firms promoted by the chairman's family, for $1.6 billion. Indignant shareholders and analysts questioned the basis for the valuation and the reasons behind the acquisition, forcing the company to withdraw the proposal less than 24 hours later. But the lack of confidence in the companyÆs management that was triggered by the announcement saw four independent directors on the Satyam board resign and the shares fall 40% in 10 days. The share price had recovered somewhat since then and as of the close of trading Tuesday it was off 21% versus the mid-December level.

It now emerges that the proposed Maytas acquisition was a last ditch attempt by SatyamÆs founders to plug the gap they had created as they had intended to defer the payment for Maytas.

After the Maytas fiasco in December, Satyam postponed a scheduled board meeting to January 10 and appointed DSP Merrill Lynch as financial adviser to explore options to create shareholder value. The investment bank terminated its engagement the day before yesterday citing material accounting disclosures found during the course of the engagement.

Satyam was founded by Raju in 1987, but his family currently owns less than 10% of the firm. It has more than 55,000 employees, whose fate is currently uncertain.

IndiaÆs company affairs minister told media yesterday that the role of both SatyamÆs auditors and board will be under scrutiny. Pricewaterhouse Coopers has been SatyamÆs auditors for the last six years and a number of bloggers have questioned how the accounting firm could have overlooked the irregularities which have now emerged. They have likened the situation to the Enron scandal which brought down Arthur Andersen.

SatyamÆs shares lost 78% on the Bombay Stock Exchange yesterday to close at Rs40 and dragged down the Sensex by 7.25% to a close of 9,587 points. Some bankers attribute the bearishness across Asian markets yesterday afternoon to Satyam's announcement and nervousness that similar accounting frauds may emerge in other firms. In India specifically, the information technology firms and the outsourcing sector are likely to see some backlash due to a loss of confidence and not surprisingly a number of smaller Indian IT players lost ground yesterday.

Some fund managers are more optimistic and suggest the impact could be short term. "This unfortunate development will be a short-term negative for market sentiment," says Sukumar Rajah, chief investment officer, equity at Franklin Templeton Investments India, in a written statement. "However, further tightening of regulations and oversight mechanisms for auditors emanating out of this incident should be a long term positive for India."
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