Satyam @ Tech Mahindra: A bailout or sound acquisition?

15 Apr 2009,

Much has been written about the speed and effectiveness with which the government-appointed board restored systemic confidence by finding a suitor for Satyam. There is no doubt in this regard as also the fact that most constituencies (employees, IT industry, government, markets, overseas investors and politicians) will find this outcome laudable.

Even after a day, I am still unclear about the possible motivations behind the almost seemingly desperate attempt by Tech Mahindra to snap up Satyam. Its bidding price of Rs 58 was almost three times that of the bid of the only other “dispassionate” bidder, Wilbur Ross, at Rs 20 per share.

L&T’s bid at Rs 45.90 is not quite relevant as its interest in this deal arose primarily out of its need to salvage its reputation dented by its previous indiscretion in a poor market transaction. If Tech Mahindra’s sole intention was to diversify its revenue streams and buy scale, surely it could have considered many “untainted” companies which are available in the current depressed environment and are screaming buys on the valuation front, both in India and the rest of the world.

The primary interest of any acquirer in such transactions is predicated on the basis of three criteria: full clarity on the financial position, demonstrated continuing customer commitment and, consequently, a reasonable view of its revenue/ profitability projections in the medium term.

Satyam does not fulfill any of these criteria . Continuing customer commitment can only be gauged after existing IT projects are completed, and a post-scam time-frame of three months is too early to judge this factor. In fact, if reports are to be believed, roughly $200 million worth of customer commitments have reduced per month for the last four months!

The fact that TM does not have vertical expertise in non-telecom areas will surely not help matters on this front. Free cash flow and profitability do not exist at the moment for the company. Additionally, the issue of undetermined liabilities arising out of class action suits and Upaid litigation needs no reiteration.

The fourth component of any such transaction is the ability of the acquirer to manage the acquisition. In this case, this would imply additionally managing a ‘turnaround’ as well. Does TM have this capability? Though Vineet Nayyar and his team have a reputation for working as a close-knit team, they are more known for their deal making strengths rather than effecting complex turnarounds.

Though TM has grown under their guidance at a much faster rate that what MBT managed over the 18-odd years prior to that, it is a fact that the concentration of BT revenues is still about 60% and the companies’ success in growing the non-BT business has been limited. Satyam will test the turnaround capability of the management to its hilt in all its aspects.

A hands-off owner expecting to run the company with a very similar senior management team which ran Satyam with Raju will have serious, and unanticipated, consequences detrimental to the interests of customers and investors. From my understanding of the management bandwidth at TM, which runs as a very tightly run ship, there are not enough members of the top management team who would be able to spare time to directly oversee and manage operating challenges on a day-to-day basis at Satyam.

The fifth issue is of financing: despite the claimed operating cash flow of Rs 700 cr, the transaction would still require taking significant leverage on TM’s balance sheet to fund the Rs 3,000 cr needed for the acquisition . In this environment of constrained credit markets, the cost of raising this capital will be prohibitive either in terms of interest on debt or dilution in case of a private equity placement. Is this desirable?

Maybe it is desirable but only if available at firesale prices. And this is what I find most surprising: TM has valued Satyam at a revenue multiple of approximately 1x which is largely similar to, or in many cases, more than the market multiples of established global IT players in the current environment. Just as a data point, Accenture quotes at 0.6x and CSC at 0.35x trailing twelve months price to sales.

It is no surprise that despite all the media hype, no serious bidder emerged for Satyam in the last weeks. This includes the likes of IBM, CSC, Cognizant, Accenture and the prudently run, large Indian IT services providers like Infosys, Wipro and TCS.

And given that the timing of the deal coincides with the first phase of elections two days later in Andhra Pradesh, perhaps the desperation to conclude the deal makes sense only if viewed as a bailout provided to the UPA in general, and the Congress leadership in AP, in particular.

And what about TM? Given M&M’s ageold linkages with the political dispensation, the quid pro quo could emerge post-elections either in terms of defence contracts or telecom regulations to facilitate BT’s entry in telecom services. Or indeed, in an extreme scenario where future contracts and employees are slowly transferred to TM with Satyam being relegated to a shell company with all the attendant litigation risks.

Who knows? Only time will tell. Or the stock price movements and the non-promoter shareholding pattern of TM after the initial euphoria blows over.

(The author is a Sloan Fellow from the London Business School, CEO of Diptish Investments and Fund Advisors and the former Group CFO of Polaris Software)