The Satyam Shocker explained

Now that I’ve gotten over the stomach upset that Raju and Satyam managed to give me yesterday, I’ve digested the news a little better. And guess what, I’m feeling queasy all over again.

It’s time for our business reporters to discover real rates being paid by fortune 500 companies to Indian IT companies. If the rates are similar to Satyam’s rates for similar services, we’re in trouble.

There’s no point sugar coating this: according to Raju’s letter, Satyam’s real profit margin is 3% and not the 24% that they reported during the last earnings season.

Now, they used 24% as a number because that’s the number all the major IT companies use as their “operating” profit margin, which is not the net profit … that’s calculated later.

In lay-(really lay)-man’s terms, all the IT companies have been saying that for every 100 rupees earned, they spend 76 rupees on operational costs, and have 24 rupees as operating profit. This 24 rupees then gets further reduced as capital costs are factored in, leaving a net profit. And so, everybody goes home happy.

Now when the operating profit margin is 3% across all their clients, things get really interesting. Again, I’m using interesting here in the completely Chinese sense — as a curse.

This number is an average, which means that there are some clients who Satyam will be servicing at a loss, and some where Satyam will be making perhaps 10%. Either ways, this means Satyam has been making a net loss every quarter. Which is why Raju had to borrow money personally … to keep the company afloat.

Did I mention my wife bought Satyam stock in 1999, when it traded for over 1000 rupees. As you can imagine, she’s unwell.

Now, what if this 3% is the real profit margin not just for Satyam but for other IT companies as well. I find it hard to believe that large fortune 500 companies will pay Satyam a lot less than Infosys. My guess is that rates for similar services will be similar. So until and unless Satyam ran a very loose ship (in terms of operating costs) and again, my guess is that they didn’t, all the major IT companies charge similar rates. So, exactly how inflated is this 24% operating margin?

What this means for small investors like you and me, is that we can no longer trust audited numbers put out by any company that suggests an operating profit margin of more than 5-10 per cent. Think about it, if you were a client negotiating with multiple IT companies, and one of them offered to do it for 20 per cent less than the others, wouldn’t you beat down everybody else’s prices?

Bringing me back to my first point: It’s time for our business reporters to get investigative and figure out what people have been paying Satyam, and then compare that to what people are paying Infosys, Wipro, TCS etc for similar services. In fact, it would be nice if all these companies came forward themselves, but I don’t see that happening. And even if hell freezes over and it does happen, I don’t see how we can trust their numbers.

Recovered from the site’s WordPress archive, where it was published on 2009-01-07.