Here is an excerpt from our 15 December 2008 commentary. We never expected Satyam to be the first one on our list.
"Every bull market has its share of fraud companies. They somehow declare fantastic results and manage to give the most spectacular returns on the way up. Investors typically chase them on the downturn because they appear to be cheap. These are the ones that do most damage to our portfolios. Fortunately, the bear market filters them out and you have a clean lot at the end of the bear market. Give another four quarters and you will know the difference between the good and bad. Till then stick to companies that are old with proven track record and have size and liquidity. "
It's quite normal for frauds to come out when the market stops supplying companies with easy cash. While there we always doubted the integrity of Satyam, even we are shocked at Ramalinga Raju's disclosures about the fraud in Satyam. He says the cash was never there. What does this mean?
We don't know, but here is what might have been done.
Entries were being passed to show fictitious revenues. To show receipts against these bogus billings, fictitious bank accounts were opened in the 'books' of the Company. Entries must have been passed to show that money was received from bogus clients and parked in these fictitious bank accounts. To ensure that auditors don't question these things, several documents would have been forged - bank statements, documents required from autorised dealers as paperwork for overseas remittances. Regulators don't get wind of these things because they were not even involved. It's unlikely that anyone is relating the data in the Annual Report to the data with the Authorised Dealers.
Perfect paper work would ensure that the auditors don't get wind of all this. The directors have no way of knowing all this. After all they are there only at Board Meetings and have to rely on the information given to them. Even in their wildest dreams they could never have imagined such a big fraud was going on under their nose. We can't blame the Directors or senior management team because the financial matters are based on the documents made available to them. Someone who has gone to a fraud of this extent would easily have fudged all the papers to the Board as well. When the auditors also haven't got a whiff of this fraud, how can one expect directors (who are not party to this) to have any idea about this.
Old timers in the market will remember similar frauds - Fairgrowth Financial Services Limited, Bangalore, which had been issuing bogus Letters of Credit and had been forging all the related paperwork.
This fraud may have gone on for more than a decade. The 1998-2000 period was a fatastic period for these companies. By merely selling a small fraction of their stake they could raise plenty of cash to make the balance sheets healthy and growing. As IT industry started losing fancy, the currency dwindled and it became more and more difficult to cover up the fraud. Many companies would have done this of the last four years - in the name of infrastructure, mining, etc. Whenever the market starts valuing companies beyond reasonable fair value, it makes fraud a viable business proposition.
There are only two criteria that can separate the good companies from the bad:
- how much tax are they paying?
- how much dividend are they paying?
Any company that pays a good amount of tax and has a good payout ratio, especially when the stock markets are down, is definitely generating good cash flows and deserves a premium valuation.
SATYAM FRAUD HAS CHANGED THE WAY INVESTORS WILL LOOK AT COMPANIES.
INVESTORS WILL NOW ASSUME THEY ARE GUILTY UNLESS THEY ARE PROVEN NOT-GUILTY.
"Every bull market has its share of fraud companies. They somehow declare fantastic results and manage to give the most spectacular returns on the way up. Investors typically chase them on the downturn because they appear to be cheap. These are the ones that do most damage to our portfolios. Fortunately, the bear market filters them out and you have a clean lot at the end of the bear market. Give another four quarters and you will know the difference between the good and bad. Till then stick to companies that are old with proven track record and have size and liquidity. "
It's quite normal for frauds to come out when the market stops supplying companies with easy cash. While there we always doubted the integrity of Satyam, even we are shocked at Ramalinga Raju's disclosures about the fraud in Satyam. He says the cash was never there. What does this mean?
We don't know, but here is what might have been done.
Entries were being passed to show fictitious revenues. To show receipts against these bogus billings, fictitious bank accounts were opened in the 'books' of the Company. Entries must have been passed to show that money was received from bogus clients and parked in these fictitious bank accounts. To ensure that auditors don't question these things, several documents would have been forged - bank statements, documents required from autorised dealers as paperwork for overseas remittances. Regulators don't get wind of these things because they were not even involved. It's unlikely that anyone is relating the data in the Annual Report to the data with the Authorised Dealers.
Perfect paper work would ensure that the auditors don't get wind of all this. The directors have no way of knowing all this. After all they are there only at Board Meetings and have to rely on the information given to them. Even in their wildest dreams they could never have imagined such a big fraud was going on under their nose. We can't blame the Directors or senior management team because the financial matters are based on the documents made available to them. Someone who has gone to a fraud of this extent would easily have fudged all the papers to the Board as well. When the auditors also haven't got a whiff of this fraud, how can one expect directors (who are not party to this) to have any idea about this.
Old timers in the market will remember similar frauds - Fairgrowth Financial Services Limited, Bangalore, which had been issuing bogus Letters of Credit and had been forging all the related paperwork.
This fraud may have gone on for more than a decade. The 1998-2000 period was a fatastic period for these companies. By merely selling a small fraction of their stake they could raise plenty of cash to make the balance sheets healthy and growing. As IT industry started losing fancy, the currency dwindled and it became more and more difficult to cover up the fraud. Many companies would have done this of the last four years - in the name of infrastructure, mining, etc. Whenever the market starts valuing companies beyond reasonable fair value, it makes fraud a viable business proposition.
There are only two criteria that can separate the good companies from the bad:
- how much tax are they paying?
- how much dividend are they paying?
Any company that pays a good amount of tax and has a good payout ratio, especially when the stock markets are down, is definitely generating good cash flows and deserves a premium valuation.
SATYAM FRAUD HAS CHANGED THE WAY INVESTORS WILL LOOK AT COMPANIES.
INVESTORS WILL NOW ASSUME THEY ARE GUILTY UNLESS THEY ARE PROVEN NOT-GUILTY.
Vivek Bhargava
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