The NelsonHall Perspective on Satyam

(Any reference to revenue breakdowns are based on fiscal Q1 2009 - the period ended June 30th 2008 - as reported results as fiscal Q2 2009 reporting will be more dubious.)

Satyam Clients

To give an extent of the size of the client base, in fiscal Q1 2009 Satyam claimed to have 630 active clients, including 180 Fortune 500 accounts. Most of these will be spending under $1m per annum with Satyam. In Europe, for example, Satyam claimed to have 160 active accounts in fiscal Q1 2009, of whom 24 were generating over $5m revenues p.a.

Clients, particularly publicly quoted organizations such as GE, Nestle, DuPont, Qantas and BP will be considering transferring business away from Satyam (which could benefit Infosys, Wipro, and TCS). The issue is not about quality of service (Satyam had many highly satisfied clients), nor even necessarily about fears of business continuity (though doubts about the payroll continue) but about the impact of having Satyam as a supplier on the client’s stock market position – reflects badly on their own corporate governance. U.S. organizations are likely to particularly nervous about this and the fastest to cancel contracts. For example, one of Satyam’s Top 10 clients State Farm Insurance Co, has already cancelled its contract.

The bulk of Satyam’s business is applications development and management (ADM) services and project services around packaged applications. Fiscal Q1 2009 revenue breakdown by service type was reported to be:

• ADM, Consulting and Enterprise Business Solutions 89.3%
• Extended Engineering Solutions 6.8%
• Infrastructure Management Services 3.9%

(BPO was a very small part of Satyam’s business and Aegis BPO has already sent an expression of interest to the Satyam board, indicating its interest to acquire Satyam BPO).

Organizations typically have a portfolio of suppliers for ADM services; these other suppliers are obviously keen to pick up new business (plus other U.S. headquartered suppliers with extensive Indian operations). However, Satyam was often very aggressive in its pricing: one question is whether clients will be ready/able to pay slightly more when transferring to another service provider. Given the questions now about Satyam’s actual headcount, it could be that Satyam was undercutting on an FTE basis, but exaggerating the number of FTEs providing certain services. 

For Satyam’s largest contracts, a wholesale transfer of a delivery unit to another service provider is not out of the question: in this situation the client would have continuity of service and personnel. This is possible for dedicated delivery units.

Interested parties such as Larsen & Toubro (L&T, currently Satyam’s largest shareholder) will be more interested in buying pockets of Satyam’s business than the whole company. Reasons preventing L&T and other parties from being interested in buying the whole of Satyam, apart from the recessionary environment, include Satyam’s image now being tainted, Satyam facing litigation in the U.S. (class action suits from investors) and also in other continents, and some large bank loans to be paid. The parts of the business that are most vulnerable (least likely to have buyer interest) are some of the small regional onshore support hubs such as those in Australia.

Europe
In Europe, major accounts are:

• U.K: Aviva, BP, Bird’s Eye, Barclays, BT, BBC, Ford, GSK, Nissan, Sony, Symbian, Tesco, Thomson Reuters, Unilever
• France: Arcelor Mittal, France Telecom, GDF-Suez, Renault, L’Oreal, Saint Gobain, Total, Valeo • Benelux: Bridgestone, Caterpillar, Dexia, Johnson&Johnson, KPN, Philips, Reed Elsevier, Wolters Kluwer
• Germany/Austria/Switzerland: Arvato, BMW, CIBA, DPWN/DHL, EADS/Airbus, Kuhne Nagel, Nestle, Novartis, Swisscom, TRW, Visteon, WHO
• Nordics: KMD, Nokia, NNIT, Sony Ericsson, Tele 2, Volvo
• Hungary: GE, Ericsson Services.

To take two examples:

• With Arcelor Mittal Satyam had a 3-year IT services framework agreement for its Western European IT operation. The scope included application support and IT convergence initiatives. While Arcelor was consolidating its subcontractor base, it will still be working with a number of other suppliers
• With Thomson Reuters, Satyam had a sub-contract with Fujitsu Services within a 10-year, $1Bn internal information systems transformation program. Services in scope included applications support and development, managed infrastructure services for desk side support, a global Network Operations Center (NOC) and Remote Infrastructure Management (RIM). Satyam has been providing IT services to Reuters since 2001. These services were to be delivered from a new center in Chennai as well as Satyam’s existing Reuters ODC in Hyderabad. Fujitsu Services will be transferring work, both to Fujitsu India and to its Infinite BOT operation,

The revenue distribution by vertical in Europe was approximately:

• Automotive 15%
• Other Manufacturing 9%
• Telecom/Media 15%
• Retail/CPG 12%
• BFSI 12%
• Public sector 9%
• Life Sciences 8%
• Energy & Utilities 7%
• Aerospace & Defense 2%.

Global
Fiscal Q1 2009 global revenue breakdown by vertical was reported to be:

• Manufacturing 23%
• BFSI 21%
• Telecoms/media 22%
• Healthcare/pharma 7%
• Retail/transportation/logistics 10.5%
• Others 16%.

Satyam’s largest global accounts included GE, Nestle, DuPont, Qantas, BP, Caterpillar and Motorola. All work with other providers for offshore services. GE, for example which accounts for nearly 5% of Satyam’s revenues also works with TCS and Patni. Some aspects of the relationship with GE are particularly close, for example GE Healthcare recently partnered with Satyam to provide support to health provider clients deploying GE Centricity Enterprise healthcare IT solutions. The partnership, which includes joint planning, design and implementation of infrastructures for clients as well as application integration and solution customization for providers, was targeted at the Middle East, with the companies intending to jointly staff a demonstration center in Qatar as a showcase for hospital technologies. Vendors interested in this region include Wipro.

Qantas awarded Satyam a 7-year AU$mm ADM contract in November 2006 covering over 150 applications. Qantas also awarded TCS a larger 7-year contract with an expected LTV of AU$120m. This followed a 12-month review by Qantas of its applications development, support and maintenance functions. The contract with TCS gave it responsibility for over 75% of the total scope of Qantas' Applications Services & Transformation (AST) program and TCS was the lead partner for the transition phase of the AST program and is the most likely company to take over work from Satyam.

Other more recent major agreements include:

• In April 2008 Satyam acquired the IP and assets of Caterpillar's Market Research and Customer Analytics (MR&CA) operations for $60m in cash, and set up a BU offering MR&CA services with Caterpillar as its initial client. This unit could potentially be used to service other sectors and may attract buyer interest
• In November 2008 Satyam announced an agreement with Motorola to acquire its network management software development center in Cyberjaya, Malysia, together with 128 employees. The transaction was due to be completed by the end of the year. Motorola would have had a clause in the agreement which will enable it to transfer the business back. Other services providers looking to enhance their product engineering services offerings for network equipment providers and telecoms operators might be interested in taking over this captive at a bargain price
• Engineering and construction group First Holding, who in November 2008 awarded Satyam a one-year SAP ERP implementation covering First Holding's companies in Kuwait. This is an example of a contract which will be transferred to another service provider. (In March 2008 Satyam was certified as SAP's first Strategic Services Partner in the Middle East and North Africa where it had 150+ personnel: by November it claimed to have 750+ personnel working onsite in the region).

Organizations Using/Contemplating Using Offshore Headquartered IT Services Providers: Securing Continuity Of Service

Should Organizations Now Be Wary of Indian/Offshore Service Providers?
Clearly, there have been failures, of corporate governance within Satyam, in PwC’s auditing, and in the inabilities of the financial analyst community and of Satyam’s major clients, to pick up dishonest accounting.

Satyam was a reputable and sizeable firm: the fourth largest Indian IT services provider, quoted on the Mumbai and New York stock exchanges, and its promoter group holding just a small minority of the company’s shares (4% in the last few months). What details should an organization look for other than the financial reporting?

• The membership of the board (Satyam’s was dominated two brothers, acting as CEO and CFO, and the entire board was small: it had the feel of a family owned firm). Does the board have multi-national membership? What is the background of the non-executive directors? What other links do they have with the CEO?
• The personality of the CEO: is he a charismatic and very strong willed family member? How were the CEO and CFO appointed?
• Does the company report in U.S. GAAP (as well as, say, Indian GAAP)
• Shareholder patterns: who are the shareholders and what proportion of the overall shareholders is held by the promoter group. Infosys and TCS (with relatively small promoter group stakeholdings) have emphasized their shareholding structure in their recent quarterly results: Wipro and HCL may choose not to
• How much segmental detail does the company provide in its earnings results, also do year-over-year $ growth figures match what was actually reported in the previous year period’s results? As an example, Infosys’ financial reporting is very transparent (including the impact of forex) and year-over-year comparisons of segment results are easy to make.
• Employee numbers: does the company provide details of employee breakdowns (e.g. TCS provides very detailed breakdowns of nationality and gender)? What is the level of breakdown in attrition and utilization reporting?
• Does the level of acquisitions match what would be expected from looking at the balance sheet?

Generally, the Satyam scandal poses a short-term challenge to Indian headquartered providers who are having to provide more details in this quarter’s earnings calls at the same time as having to answer queries about the recessionary environment. However, without doubt the drive to offshore IT and business process services will continue and even accelerate as cost reduction remains the most pressing concern for organizations. Satyam’s closest large competitors, also global IT services vendors such as IBM, Accenture and EDS who have sizeable Indian operations stand to gain business from the disgraced company.

The scandal may encourage India to tighten its financial reporting regulations, but factors such as the greater propensity of the market to offshore and the proven capabilities of firms such as Infosys and TCS in delivering in larger, more complex outsourcing engagements mean that such vendors will continue to thrive. The offshore firms who are likely to be impacted are the smaller and the family-run firms.

Transitioning Different Types of Offshored Services to a New Services Provider
The Satyam scandal highlights the importance of having a strategy to ensure continuity of service in the event of wishing to move away from a particular supplier, for whatever reason (e.g. quality of service, the supplier getting very close to your nearest competitor).

Services that are currently offshored tend to be:

• ADM
• BPO: customer management services, F&A, KPO, mortgage processing, and sub-process support in other areas such as HR
• Remote infrastructure management
• Testing services.

Organizations that are outsourcing:

• ADM services should continue to maintain a portfolio of suppliers for reasons of business continuity
• Call center BPO services and KPO should also continue to do likewise
• Finance and accounting BPO, while this is likely to be a sole sourced agreement, it is relatively easy to transfer activities within a few months
• Mortgage processing, most activities are fundamentally administrative in nature and can easily be transferred
• RIM, most off/nearshore activity is monitoring, and this again is transferrable
• Testing services, again, organizations should continue to have a portfolio of suppliers. Activity is project based, so there is not a real issue.

The types of BPO where it is much more difficult to transfer services providers include life and pensions (L&P) BPO and multi-process BPO. With the former, while companies such as TCS are making inroads and offshoring is on the increase, the contracts still have an onshore delivery center hub (need to avoid any confusion between offshoring and outsourcing to offshore providers). Offshore vendors have not yet made inroads into large multi-process HRO contracts. Some contracts have transitioned back in-house, but to date the issue has been one of service delivery, not of supplier stability.

Perhaps the most challenging type of contract to transfer is a sole sourced large scale ERP implementation and rollout. While this is the type of turnkey transformation deal that the Tier 1 vendors have been looking to win in recent years, the number of such deals has declined in the last year.