Rising from the flames

Peter Brudenall explains how ‘Mahindra Satyam’ was born and identifies key lessons the transaction holds for dealmakers, legal advisers and regulators

On 7 January Ramalinga Raju, the chairman of Satyam Computer Services, stunned markets when he confessed that the company’s financial statements had been manipulated for years. Raju sent a letter to Satyam’s board, stating that the bulk of the assets reported in Satyam’s second quarter earnings report – some 50.4 billion rupees (US$1.04 billion) – was fictitious. Raju further admitted that Satyam had inflated its revenues, operating margin and accrued interest, and had understated its liabilities.

Founded in 1987, Satyam had been one of India’s top IT performers, with over 45,000 employees and strategic technology and marketing alliances with no less than 50 companies.

The company plunged into crisis after what appears to have started as a small gap in the financials got out of hand. “It was like riding a tiger,” Raju wrote, “not knowing how to get off without being eaten.” What further shocked analysts was that the fraudulent balance sheets and accounts had been audited by respected international accountancy firm PricewaterhouseCoopers.

Raju’s disclosure led to a short-term meltdown of Indian IT stocks. Satyam’s stock tumbled by over 70% and sent the index of the Bombay Stock Exchange down by 7.3%. There were fears that Raju’s confession might be only the first in a series of nasty revelations of failures in Indian corporate governance.

CB Bhave, the chairman of India’s capital markets regulator, the Securities and Exchange Board of India (SEBI), described the financial wrongdoing in Satyam as an event of “horrifying magnitude”. It remains the largest case of corporate fraud in Indian history.

Defying expectations

In April another Indian-based technology company, Tech Mahindra, successfully bid for Satyam. Following the takeover, Satyam – rebranded “Mahindra Satyam” – defied all predictions of collapse. It had a resurgent share price after posting solid financial details for the first quarter of 2009.

While these are still early days for assessing the impact of the Satyam scandal, it is clear that initial fears of lasting damage to the Indian outsourcing sector have eased, and that Satyam as a company appears far more capable of continuing to serve its still-considerable client base than it did six months ago. For observers of India’s outsourcing sector it is a valuable exercise to analyse the government’s response to the Satyam crisis. There may well be important lessons for regulators, government bodies and prospective investors in dealing with similar events in the future.

Government response

In the wake of Raju’s confession, the National Association of Software and Services Companies (NASSCOM), the Indian government and SEBI immediately stepped in to stabilise the situation. The fraud had attracted worldwide interest and was quickly dubbed “India’s Enron”. Most observers believed that Satyam would collapse, with considerable implications for the reputation of the Indian technology and outsourcing sector.

Peter Brudenall is a partner in the global technology and outsourcing group at Hunton & Williams. He is based in London.