Satyam (SAY) Red Flags
Fraud seems to get exposed when the tide comes in, although a lot of simple things could be done on behalf of regulators to become more proactive instead of reactive. I won’t go into details on how this can be accomplished because David Einhorn’s excellent book Fooling Some of The People All of The Time, which chronicles David’s experience with Allied Capital (ALD), says it better than I can. This time around Madoff and Satyam were caught swimming naked, and I’m sure more fraud will turn up in coming months. I haven’t had much interest in Satyam as an investor, so I thought that I would get up to speed and check if there was anything on their financial statements that I could notice simply by glancing over. It turns out there are a few things that stand out that would make me question Satyam as an investment opportunity. When you see things like this, management ought to be questioned and held accountable. Remember, these were first impressions I had, not an in depth analysis. Here are my observations:
1) Starting in 2006, accruals begin to pick up, and net income starts to become substantially greater than operating cash flow. On average according to several academic studies (and common sense if you realize that all accruals are self reversing) high accrual firms underperform the broad market, while low accrual firms outperform the broad market. Using this type of screen can be a useful starting point for finding short sale candidates.
2) One thing that probably threw a few analysts off was where these accruals were coming from. To throw unprepared analysts off the scent, Satyam stuffed the accruals in “other current liabilities”, an annoying catch all category that sometimes goes unnoticed. While revenue was only up around 38% between FY05 and FY06 and 46% between FY07-FY08., the “others” were up 264% between FY05 and FY06 and 164% between FY07 & FY08. I haven’t checked what the catch all “others” consists of, but this would be something that a good analyst would have investigated.
3) It seemed that long term investments were being bundled with cash equivalents & short term investments in 2006 and 2008, while being classified in its own category in 2005 and 2007. While this doesn’t necessarily mean anything in and of itself, it seems unusual, at least in my experience, to see this.