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Peter Lynch had a term for it: "deworsification." Another phrase might be "raiding the shareholder's larder."
Spending $1.6 billion to buy a couple of family-owned businesses was more than the market could bear from Indian IT outsourcing specialist Satyam Computer Services (NYSE: SAY ) . With investors in open revolt, the stock tumbled more than 50% on the day.
The IT industry is facing some bleak prospects for the immediate future, and it seemed ludicrous for Satyam to be purchasing the distressed assets of the chairman's sons' even if Maytas Properties and Maytas Infra would "de-risk" Satyam's core business. Instead, it looked like a bailout of family members by overpaying for them (Maytas, by the way, is Satyam spelled backwards). The real estate business, for example, has a net worth of only $225 million, but Satyam was going to pay $1.3 billion for it. In fact, the entire deal would have wiped out all of the company's $1 billion cash position and substituted a net debt balance of $400 million.
Satyam has seriously damaged its corporate governance reputation, at least for the time being. Despite having won awards in the past for its governance practices, the consultant certainly has raised some warning flags. It also hurt much of the rest of the IT segment as Cognizant Technologies (Nasdaq: CTSH ) , Infosys (Nasdaq: INFY ) , and Wipro (NYSE: WIT ) also fell, though not by nearly as much.
All in the family
Yet, such cozy deals aren't uncommon, though the size of this one raised eyebrows. Last year, for example, home decor outlet Bed Bath & Beyond (Nasdaq: BBBY ) bought baby-goods retailer buybuy Baby from the sons of its co-chairman. They rationalized the purchase by saying that since women shop for home goods, selling pregnant women and new mothers baby stuff was a natural extension. Although the deal "only" cost $67 million, they might as well have opened an auto parts store since women drive cars, too.
Gap (NYSE: GPS ) also doles out cash to family members, typically using the construction company of its founder's brother to build its new stores. Maybe it's the recession or a slowing of the number of new store openings, but Gap paid only $300,000 to the brother last year, down from $21 million in 2005. Quiksilver (NYSE: ZQK ) is another example of a company that had to take big losses for its purchase of ski-maker Rossignol in a bid to help out a family friend.
Such related party transactions can become a minefield for investors navigating through them. It should be enough to make an investor think twice before investing in a company that has such cozy relationships with relatives.
Feel the heat
Satyam chairman Ramalinga Raju quickly backpedaled after getting an earful from investors, saying that although they still thought it was a good way to diversify, they were heeding the investor anger.
While there might be something to the notion that IT services have a bleak outlook at the same time the construction industry stands to benefit from a large infusion of government spending in the country's infrastructure, it's equally plausible to build the case that it was little more than a means to enrich family members caught in a depressed industry using Satyam shareholder wealth. Considering that its board of directors approved the deal, investors may want to keep that in mind as well when they come up for re-election.
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