Why Satyam Backpedaled So Fast

The Indian tech giant hastily scrapped a $1.6 billion deal to buy two construction companies after investors revolted

Late in the day on Dec. 16, Satyam Computer Services, the fourth-largest IT-services enterprise in India, announced the $1.6 billion acquisition of two construction companies, Maytas Infra and Maytas Properties. Ramalinga Raju, the founder and chairman of Hyderabad's Satyam, called the purchase of the companies "a good diversification strategy" and said Satyam had no need to seek approval from shareholders.

It didn't take long for shareholders to protest, though. Foreign investors, who own nearly 47% of Satyam's stock, quickly registered their dismay by dumping the company's Nasdaq-traded American depositary receipts on Dec. 17. Satyam's ADRs plummeted, dropping 50% during New York trading. Nine hours after Satyam had announced the deal, the company reversed itself and canceled the acquisitions. "We were quite positive about the merits of the acquisition. However, in deference to the views expressed by many investors, we have decided to call it off," Raju said in a press release.

That may not do much to improve Satyam's reputation for corporate governance, and it could spook the company's global outsourcing clients. Since Maytas Infra and Maytas Properties are run by Raju's two sons, Teja and Rama, angry investors are now asking how the deal got as far as it did. "Why did the board not oppose the move? Who voted for and against the resolution? Was the board truly independent?" asked a Dec. 17 CLSA report on the Satyam announcements.

Damaging Ripples

Already, brokerages Kotak Securities and Citi (C) have issued aggressive "sell" calls on Satyam and are urging investors to change allegiance to other IT companies like Infosys (INFY) and Wipro (WIT). The worry is that the incident could have broader repercussions for other Indian firms. "Everything about the aborted deal was so dubious that it has the potential to impact corporate governance perceptions about India," says Harit Shah, analyst at Mumbai's Angel Broking.

Arup Roy, senior research analyst at research firm Gartner (IT), says many foreign IT clients were already apprehensive about moving their offshore business to India after the November terror attacks in Mumbai. "Global companies are always looking at the ethical practices of their vendors, and the value they create for their shareholders," he says. "The Satyam brouhaha could further dilute their belief in India."

Why did the deal create such a furor? Raju's family holds an 8.6% stake in Satyam, and the founders and their associates would have benefited greatly from the Maytas deals. In the Dec. 16 conference call with investors, when Raju announced the deal, he refused to identify the investors in Maytas Properties. "It's a combination of family and friends, and it will be difficult to give an exact break-up," he said.

Raju declined to be interviewed for this story. The real estate downturn in India and the market fall had diluted Maytas' assets in infrastructure projects and real estate development. Since January, Maytas Infra's stock price is down 66%, to 6.

Keeping Mum

It's not clear who was advising Satyam on the deal because the identities remain a closely held secret. Speaking on Dec. 17 with analysts, Satyam's CFO, Srinivas Vadlamani, said: "We have been advised by a reputable firm from among the top four. This is the right time for diversification into another sector. It was a unanimous board decision." (BusinessWeek called the top four firms—PricewaterhouseCoopers, Satyam's auditors; Ernst & Young; KPMG; and Deloitte. Officials at E&Y and KPMG denied involvement, and spokespersons for Deloitte and PwC said they didn't know anything about Satyam's advisers.)

It's also difficult to know what role the company's high-profile board played. They include Harvard Business School Professor Krishna G. Palepu; Mendu Rammohan Rao, dean of the prestigious Hyderabad-based Indian School of Business; and Vinod Dham, a venture capitalist and former Intel (INTC) executive who earned fame for his role in the development of the Pentium chip.

Satyam has faced questions about its corporate governance in the past. In 2000, investors were livid when the company offered rights issues in a subsidiary and tried to favor a family member of the founder. After the dot-com bust of the early 2000s, a CLSA report questioned Satyam's accounting practices, citing "large accounting gaps" in the company's Internet businesses and joint ventures. Those incidents have weighed on Satyam's valuations over the years. "Despite being the fourth-largest IT player, the company has traditionally traded at a discount to its peers," says Angel Broking's Harit Shah. Raju's associates say the issue has peeved the founder for years.

Many investors want a management shake-up. To win back investor confidence, the company has scheduled a Dec. 29 meeting to discuss a share buyback. That alone won't likely fix everything, though. Gartner's Arup Roy thinks Satyam has to funnel more resources into PR, marketing, and sales. He predicts: "Satyam will find it difficult to win clients in the future."

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