Satyam-Maytas deal: Impact on the companies

Think of Satyam Computer Services (Satyam) now and you can't help but recall the advice of the richest human on this planet, Warren Buffet: "It takes 20 years to build a reputation and five minutes to ruin it.

If you think about that, you'll do things differently." Last week, India's fourth largest software exporter, Satyam, faced a backlash from investors after it announced a decision to buy real estate and infrastructure companies, managed and controlled by the sons of Satyam's founder-chairman Ramalinga Raju, for $1.6 billion.

Within a few hours, a chastened Satyam called the deal off. The developments come on the heels of recently called off re-organisation plan of Sterlite Industries. The silver lining though is that quality managements will command a premium.

For now, there are many questions that crop up. What are the undercurrents of the deal? What impact can this incident have on the future of the concerned companies? Should investors hold on to these stocks? To know the answers, read on.

Defeating logic
The proposed deal to buyout 100 per cent stake in Maytas Properties for $1.3 billion and 51 per cent stake in Maytas Infra for $300 million is difficult to digest. The deal, had it gone through, would have consumed all the surplus cash on the books of Satyam, which is estimated to be $1.1 billion. The acquisitions would have netted the Raju family $570 million (they hold a 35 per cent stake in Maytas Properties and 36 per cent in Maytas Infra), while exhausting Satyam's cash reserves and leading it to raise $400 million of debt, leave alone the debt that would have added to its books on account of the acquired entities.

The explanation, provided for the said deal was to de-risk the business model of the company, in the light of a bleaker business outlook for the IT services company. But, to diversify so radically at a time when Satyam's rivals are hoarding cash to weather a global slowdown is disconcerting. A look at the margins of Maytas Infra (financials of Maytas Properties not available) also suggests that the margins of the combined entity would have stood reduced after the deal.

Ulterior motives?
The fact that the promoters of Satyam, who hold less than 10 per cent stake in the company, went ahead with the deal without the approval of its minority shareholders, just because it was "not required as per regulations", shows that corporate governance was not exercised in "true spirit" and yet again brings to surface, loopholes in the system. This, despite the fact that it was a related-party transaction and that it would have changed the risk profile of the company. "It is also difficult to fathom, why the company did not prefer a three-way stock-based merger of the entities, which would ensured that the cash would continue to stay in the system," says Viju George, analyst, Edelweiss Securities. The disclosure on the shortlisting process and valuations for the two target companies is also not sufficient, which seem grossly expensive.

High valuations
As per the deal, Maytas Properties (unlisted) is being valued at Rs 91.47 lakh per acre (Rs 6,220 crore; land bank of 6,800 acres), despite the fact that bulk of the land is in tier II and III cities such as Vizag, Vijaywada, Kakinada and Nagpur. Analysts say that, on a realistic basis, the per acre price should average at Rs 40-45 lakh per acre or even less, given the current scenario.

On the other hand, Maytas Infra has been valued at nearly 1.6 times FY08 revenues even as mid-cap construction stocks on an average are trading at less than half their FY08 revenues. Even on a P/E basis, the valuations are high.
 

LOOKING BEYOND NUMBERS
Rs in crore	Satyam Com		Maytas Infra
	FY09E	FY10E	FY09E	FY10E
Net sales	11,403	12,633	2,154	3,238
EBITDA	2,600	2,705	268	450
EBITDA (%)	22.8	21.4	12.4	13.9
Net profit	2,267	2,363	112.6	149.5
EPS (Rs)	33.4	34.6	19.1	25.4
P/E (x)	4.9	4.7	13.0	9.8
Source: Bloomberg

At Satyam's cost?
While Maytas Infra has a well-established presence in road and water segments, its moves into sectors such as ports, metro rail and airports has helped it bag lucrative projects in this space. The company has been awarded the Rs 1,590 crore project for the development of a deep water port at Machilipatnam, Andhra Pradesh on a built-own-operate-transfer (BOOT) basis. More recently, the company bagged the Rs 12,132-crore Hyderabad metro railway project through a consortium; again on a BOOT basis for a period of 35 years. Together, Maytas Infra's order book now stands at about Rs 11,000 crore. Analysts, however, point out that one of the primary reasons for the company winning these orders has been its aggressive bidding. Additionally, the company is yet to arrange for about Rs 1,300 crore required over the next two-three years towards the metro and other BOOT projects.

Little wonder, analysts and shareholders are thinking alike: Was the deal an attempt to bailout the two Maytas companies, which would be hard-pressed to raise funds in such trying times? Maytas Infra's total loans stood at Rs 934 crore in FY08, significantly up from Rs 260 crore in FY07. By getting into the Satyam fold, the two companies would have benefited from the combined balance sheet size, which would not only help them to raise funds for their ongoing projects but also bid for bigger projects.

Moving to a safe harbour
Though the withdrawal of the acquisition plan, which was soon followed by a proposal to buyback shares, is likely to mitigate a stock sell-off to an extent in the Satyam counter, analysts feel that the episode has permanently dented confidence of the investors. Concerns relating to management focus, client comfort and continuity, employee motivation and good corporate governance will linger on, for a long time to come. "This is the time when clients are aggressively looking for vendor consolidation. This development could result in Satyam losing out to peers like Infosys, Wipro and TCS," says Anurag Purohit, analyst, Religare Hichens, Harrison & Co. Analysts expect Satyam's valuation discount to peers to widen to the tune of 40-50 per cent. "We believe that this incident has impaired the management's reputation. This is likely to result in de-rating of the stock," said Gaurav Dua, head - research, Sharekhan. Investors are thus, advised to exit the counter on the occurrence of a rally and switch to the likes of Infosys and TCS, which have a proven track record and high-quality corporate governance.

In the near-to-medium term, the only way Satyam shareholders could lose out if they switch to other IT bigwigs is if there are major positive developments--- Satyam being acquired by a competitor, institutional shareholders (61 per cent stake) undertaking a proactive role in the company's management, announcement of huge special dividend, etc.

On the other hand, Maytas Infra had outperformed its peers (due to expectation of the deal and receipt of orders) in the past 3-4 months. "A section of the market may have known about the deal," feels Shailesh Kanani, analyst, Angel Broking, explaining the reason for the stock's performance. But, since December 16, Maytas Infra has fallen by 49 per cent in three trading sessions and, could correct further given its relatively higher valuations (PE of 5-7 for FY10 enjoyed by its peers).