Satyam crashes with $1 billion cash hole

In a shock announcement this morning, Satyam, India's fourth largest outsourcing companies reported that B Ramalinga Raju, founder and chairman has resigned following an admission that there is an estimated $1 billion cash hole in the company's balance sheet. The company's shares crashed 77% in the aftermath. According to Finextra:

In his resignation letter to the board, Raju says that the firm's balance sheet, as of 30 September 2008, has a hole of around $1 billion. The sheet of Rs5361 crore includes "non-existent" cash and bank balances of Rs5040 crore.

Revenue for the second quarter was actually Rs2112 crore, not as stated Rs2700 crore. Operating margin was just three per cent of revenue, not the reported 24%.

The gap in the balance sheet "has arisen purely on account of inflated profits over a period of last several years".

Raju says a minor gap between actual operating profits and those reflected in the company's accounts grew over the years before reaching "unmanageable proportions".

The company's recent aborted move to buy the Maytas construction firms - partly owned by Raju and his family - was the last attempt to fill the "fictitious assets" with real ones.

"It was like riding a tiger, not knowing how to get off without being eaten," says Raju.

Apart from regulatory issues, this latest scandal raises the specter of a possible customer mass exodus. In a conversation I had with compliance colleague Francine McKenna, she said: "Satyam already had credibility problems with the World Bank. If things are really as bad as they are claiming then the company's long term future is in serious doubt." Both of us are shocked at the scale of the problem because it seems inconceivable that PricewaterhouseCoopers, the company's auditors did not know what was going on.

In many of these kinds of fraud where assets are overstated, management hides the fact through inventories, receivables or, as was the case at Enron, through special purpose vehicles that have the effect of moving debt off the company's books. Cash balances are much harder to manipulate without deliberate deception. That usually involves the actions of high ranking employees who are able to persuade the auditors to rely on their word, rather than undertaking direct enquiries with the company's bankers.

At this early stage, it is not possible to say exactly how Satyam engineered the fraud but regardless, it draws into question the general viability of the Indian outsourcing market.

In a twist to the story, Satyam was also stripped of its Golden Peacock corporate governance award:

P N Bhagwati, chairman of Golden Peacock Awards, has sent a letter to G Jayaraman, global head- corp goverance and company secretary of Satyam, saying that the award "was obtained as a result of non-disclosure of material facts" and therefore, "Satyam does not deserve it."

And in a close of year blog post, Brian Sommer felt the company needed putting out of its misery. Today, that has become an imperative.