Kotak Suspend rating and target price
• Reputation damage difficult to undo
• Concerns on cash utilization still remain—US$430 mn lying in current accounts
baffling
• Potential disruption in the IT services business plausible
• Suspend rating and target price
In a bizarre sequence of events, Satyam proposed and then revoked the proposed
acquisition of its affiliated real estate and infrastructure companies. We believe that the
reputation damage in the minds of all the major stakeholders viz. the non-promoter
shareholders (who hold 90%+ of the company), employees, business partners, and clients
would be difficult to undo. In addition, the negative press that the company would receive
on the event may also negatively impact the cash generating IT services business. We had
previously raised issues about use and deployment of cash especially the increasing
amount of cash balance in current accounts (Rs20 bn at end-2QFY09) (please refer to our
note on Satyam dated Oct 20, 2008) and believe that the market may no longer be
charitable to the company on such issues. We expect a structural de-rating of the stock.
We shall review our estimates and valuation of the company over the next few days in the
light of the event and its potential repercussion on the company’s core business prospects.
In the interim, we suspend rating and target price on the stock.
Reputation damage difficult to undo.
 We expect a structural de-rating in the Satyam
stock on account of yesterday’s sequence of events. Revoking the decision to acquire
affiliated group companies under investor pressure would do little to rebuild the lost
confidence of the market in the company’s corporate governance practices.
Concerns on cash utilization still remain- US$430 mn lying in current accounts
baffling.
 We believe that the markets would not give any benefit of excess cash in books
(Rs53 bn at end Sep-08). We had raised concerns in the past on Satyam’s cash
management (see Exhibit 1). Our subsequent discussions with the management have
failed to yield satisfactory answers. The management yesterday stated that they have
transferred some of the funds from current accounts to deposit accounts.
Potential disruption in the IT services business plausible.
We believe that serious corporate governance doubts and negative press may impact the perception of the
company amongst the stakeholders i.e. employees, business partners and customers. We
believe that these developments can impact the customer base especially in the current
environment where clients are looking to work with fewer vendors (vendor consolidation).
We are also not sure about We are also not sure about the impact of this on middle and senior management team
especially given that they had been incentivized through stock compensation in the past.
Target for hostile takeover?
Satyam is a widely held company with the promoters holding a mere 8.6%. Exhibit 2 gives the last disclosed shareholding pattern of the company. We would not be surprised to see a concerted effort for management change
and reduction in the power of the Board of Directors. We understand that under section
284 of Companies Act, specific director/directors from the Board of a company can be
removed (before the expiry of his period of office). Also under section 169, 10% or more
of the shareholders (in terms of value of underlying equity) can convene an extraordinary
general meeting to remove a director.
So what really happened?
We were baffled by Satyam’s decision to venture into completely unrelated infrastructure development and real estate businesses by acquiring majority stakes in affiliated companies. We found no synergy between the IT services and
real estate/infrastructure businesses. The proposed acquisition would have resulted in
Satyam having a net debt of about US$400 mn (in addition to potential assumed debt of
acquired entities) versus a current cash balance of US$1.1 bn. Effectively, the entire
funding obligation of the infra/ real estate businesses would have been put on Satyam,
while the promoters would have walked away with large portions of cash. We discuss the
proposed acquisitions (subsequently revoked) below.
1. Maytas Properties. Satyam proposed to pay US$1.3 bn to the founders and other
shareholders to acquire 100% stake. The management failed to elaborate on the
valuation methodology employed, shareholding structure and the bankers used for the
deal. Maytas properties has 6,800 acres of land bank, 245 mn sq ft of developable
space and projected revenues of US$90 mn for FY2009.
2. Maytas Infrastructure. Satyam proposed to acquire 51% stake (31% from promoters,
20% mandatory open offer) for a total consideration of US$300 mn. Maytas Infra is a
listed company with a market cap of US$600 mn. Maytas Infra has an order book of
US$2.5 bn and is involved in construction and infrastructure projects.

Satyam downgraded to SELL
???? Downgraded to SELL. We downgrade Satyam Computers to
SELL with a target of Rs150, based on 4.5x target PE on FY10e
earnings.
???? Maytas acquisition reversed. Satyam had yesterday announced
its acquisition of Maytas Properties (100% stake for US$1.3bn)
and Maytas Infra (51% stake for US$0.3bn). On account of huge
resistance from minority shareholders, the deal was finally
reversed late last night. This is a welcome relief, but the episode
will still raise concerns regarding Satyam’s corporate governance
for a while to come.
???? Question remains. Despite the reversal of the deal, it would still
raise questions regarding the financial health of the Maytas
entities, their promoters and its impact on Satyam finances ahead.
???? Downgrade rationale. The current turn of events raises
questions on the decision-taking abilities of the existing
management of Satyam. While we have not changed our estimates,
we capture this in our lower target PE ratings for this company.
We assign a target PE of 4.5x (same as for IT mid-caps) on FY10e
earnings of Rs34/share to arrive at a target price of Rs150. We
downgrade the stock to a SELL.

Despite Satyam’s reversal of its decision to buy out common promoter owned
realty and construction businesses, questions will linger on, perhaps for a long
time. Why did the Board not oppose the move? Who voted for and against the
resolution? Was the Board truly independent? Business fundamentals were
already deteriorating, and we are reducing earnings 14-17% for FY10-11, but
these are now peripheral to the central issue. The harm done to Satyam’s
credibility, so arduously repaired in the last few years of business
improvements, is likely to be long lasting. Our target price of Rs160 implies
1.0xFY10 book, or 5xFY10 earnings. Valuation damage will last. SELL.
The morning after
Yesterday, Satyam (where promoters own <9% equity) announced an intent to
buy out Maytas Properties (privately held, largely by Satyam’s promoters) and a
51% stake in Maytas Infra (36% owned by Satyam promoters, publicly listed).
The US$1.6bn purchase would have made Satyam’s promoters/affiliates richer by
nearly US$1.48bn, taken off all the cash in Satyam’s books, added some debt,
and put together a company with IT Services, real estate and construction as
business segments. Investor outrage at this move was well justified, and it is
some relief that this decision was reversed late last night.
A long lasting damage done
Satyam has been here before. In 2000-2003, Satyam put together a cluster of
Internet businesses, including portals and ISPs, signed on several joint ventures,
and had large gaps between stand-alone, Indian GAAP and US GAAP accounts.
The last four years had seen Satyam’s operations improve, making it the
industry’s best performing large cap stock in 2005 and then again in 2007. The
latest episode is one too many for Satyam’s credibility, however, and we suspect
that after the immediate sigh of relief at the reversal of the decision, doubts will
linger. We retain a SELL rating on the stock, from Under-perform earlier, and
believe Satyam’s case for a core tech holding has weakened for long.
Business fundamentals were already deteriorating – EPS cut 14-17%
Questions around Satyam’s corporate governance policies are ill-timed, coming
amid continuing downslide in sector-wide business fundamentals. All else
remaining the same, we have still had to cut earnings 14-17% for FY10-11, and
are now forecasting a 2-3%YY decline in US$ revenues for FY10, and a 14-15%YY
EPS drop, the worst among the top-4 vendors. Relative PE trades based on
discounts to larger peers are largely irrelevant after the latest episode, but we
fear collateral damage as Satyam defends its customer base from predatory
attacks from competition, and perhaps pricing will get even weaker. SELL Satyam.

-Excerpts from a report contributed by bloggers.

We believe that even calling off the deal approved by Satyam’s Board for acquiring
promoter-owned companies, Maytas Properties (100% stake for US$1.3bn) and
Maytas Infra (51% stake for US$0.3bn) will lead to serious doubts on the future
corporate governance of Satyam. During uncertain demand scenario, investors
will always prefer companies with proven, high-quality corporate governance.
Therefore, we downgrade Satyam to SELL from Hold. We recommend switching to
Infosys given any sharp correction within the sector post this event.
???? Investors may insist on changing the senior management. We believe that with
significant institutional investor holding (at >45%) the investors may urge a change in
the senior management, which may lead to some corporate events such as the
acquisition of Satyam. In such a case, the stock may stabilise in the medium-to-long
term in our view. However, in the interim, we expect investor interest to decline.
???? Investors may urge even a buy-back or special dividend. Owing to significant
doubts on Satyam’s corporate governance, we believe the investors may insist on
the management utilising the excess cash on the books (cash equivalents of
US$1.12bn as on September 30, ’08) by buying back equity shares or
recommending special dividend. However, in the interim, we expect investor interest
to decline.
???? Satyam stands to lose in any case. We believe that even after calling off the deal,
Satyam may find it difficult to retain key employees and this may lead to operational
issues with the clients. Therefore, we do not rule out the possibility of Satyam losing
in the current vendor consolidation wave with worsening global slowdown. Other
large-cap IT offshore services companies (even HCL Technologies) will benefit from
the likely consolidation.
???? Downgrade to SELL. This irrational corporate development would lead to a
significant fall in the stock price (to the extent of 25-30%) and therefore, at present,
arriving at a price target is difficult. We would review our rating post more clarity on
future operations. We recommend switching to Infosys given any sharp correction
within the sector post this announcement.

-Excerpts of the report Contributed by a blogger

Allahabad High Court upholds SAP of Rs140
The much-awaited decision of the Allahabad High Court on sugar-cane pricing for the sugar year 2008-09 (SY2009; October 2008-November 2009) was announced on December 8, 2008. Earlier, the Uttar Pradesh Sugar Mills Association (UPSMA) had filed a petition in the said court challenging the state advised price (SAP) of Rs140 per quintal for sugar-cane (of common variety) fixed by the Uttar Pradesh state government as “arbitrary”. The SAP for SY2009 is 12% higher than that for SY2008 (Rs125 per quintal). In its decision the court has upheld the SAP by saying that the petitioners failed to substantiate that the price fixation by the government has been arbitrary and that they could not afford to pay the said price of sugar-cane. We believe the above judgement comes as a negative for Uttar Pradesh sugar mills even as the UPSMA plans to take the matter to the Supreme Court.