Friday, February 17, 2017

Syntel - a plea for help

I don't often use the blog to find people who can just "tell me the story" but I am becoming increasingly puzzled by Syntel (SYNT:NASDAQ), an Indian outsourcing company and a competitor of Infosys and similar companies.

This is a company I have had continuously analytically wrong - but made (very small) profits. I would rather be lucky than smart (and in this case I have been lucky) but with you dear readers I hope to be lucky and smart.

I found Syntel on a systematic search for companies that were so incomprehensibly profitable that fraud was a reasonable suspicion.

Syntel was one of about thirty that came up. (Incidentally that same search generated some longs when we worked out why the businesses were so profitable...)

Anyway Syntel was full of red flags which made us investigate further for fraud. (We found no evidence of fraud in the end - but we did look.)

Here are our red flags.

  • Syntel has a fatter margin than most Indian outsourcing companies. On a quick search of Thomson Reuters the margin is about 5 percentage points fatter than most of the competitors. We could find no convincing explanation.
  • The fat margin meant the company was extraordinarily profitable. Which is well and good - except that they never paid a dividend and never bought back any shares.
  • The past profits - almost in their entirety - sat in cash and short term securities - undistributed in India. When this happens in China it is a very strong red-flag.
  • The company was run by a husband and wife team. The board seemed very incestuous - controlled by the said team.
  • A search of LinkedIn showed an enormous number of key staff who had left to competitors - sometimes for seeming demotions.
The Indian outsourcing industry has had accounting frauds before (see the major fraud at Satyam) and so I had marked Syntel as something to research and maybe do a big research piece on.

I was not the only person who thought the cash balances (which got to over a billion dollars) were weird. Here is an extract from a Seeking Alpha article referencing a conference call:

"Great, thanks. I wanted to come back to cash, unfortunately it's really the only question I have. We've heard for years, cash has been a board discussion and it's evaluated every quarter. Can you share what reluctance has been from a board level to put the cash to work from an M&A perspective? And then given, there's been sluggish growth for a couple of years, has the board's attitude towards M&A change at all or is it still just as cautious as it has been in the past?" 
Result? Complete shutdown from management - not surprising. Further, there is no chance of activist involvement here given founder Bharat Desai's stranglehold on ownership (owning two thirds of the common shares outstanding). This was of course something I knew going in, but it is something for investors to consider that are weighing their position in the company.

When management have a billion dollars sitting around that they do not use and will not explain the use of then we wonder whether something really fishy is going on. 

This company just seemed too profitable. And when something is seems too good to be true it often is too good to be true.

Failed research

At Bronte we are a fairly paranoid about companies that seem too profitable. We see 2+2=4 and think we ought to investigate for major fraud.

We spent about a week on it and got nowhere. We simply could not find anything beyond these red-flags. 

However I could not convince myself of the excessive profitability either - so I kept a small - and I mean tiny - position short - just to force me to monitor results in the hope I would finally really work it out.

Alas this disappeared into the (fairly extensive) list of things that I wanted to spend a couple of months researching - maybe to put out an extensive (and negative) research report.

And then it was forgotten.


Comprehensively wrong

There are those moments when you realise you are comprehensively wrong. Syntel gave us one of those moments. 

They paid a dividend.

Not an ordinary dividend - a billion dollars - $15 per share in dividend which is a lot given the current stock price is $20. All of those stored up cash and securities were liquidated and sent as cash to the shareholders.

Whatever: we thought the company might be faking its margins - but it is was not. And we know for sure it wasn't because they sent a billion dollars of cash out to shareholders. It is easy to fake accounts (they are numbers filed electronically with the SEC). It is to our knowledge impossible to fake the distribution of cash to shareholders. 

And so we were comprehensively wrong. We turned around and bought back our short (remarkably at a small profit).

What to do when you are comprehensively wrong...

I have learned from experience that when I am comprehensively wrong about a short it is often very profitable to turn around and go long the same stock. Usually I short funky companies and they are funky for a reason - they are designed to bamboozle onlookers.

But sometimes funky companies are funky because they have worked out something truly new - some better mousetrap - and they just seem weird. 

Those companies make good speculative longs. 

So we bought a tiny position in Syntel and decided (so far with little luck) to investigate it as a long. 

One of the things we decided was that because the cash was real (see the dividend) then the underlying business really was as it seemed. And we read the past dozen or so conference calls and decided the management were mostly matter-of-fact. They would tell you when the business was turning better or worse. And they were probably right. 

Given management statements and past results the stock was - we guessed - trading at about 9 times earnings of $2.40 or so for 2017. Given shareholder friendly management (see that dividend) and what seems a superior business (see that margin) that did not seem unreasonable.


Today's results

Syntel today announced results that were not (very) inconsistent with guidance but they simultaneously guided down pretty sharply and the stock was off 17 percent. The small (dumb luck) profits we made on the short we have mostly given back. 

That said the results are not objectively bad. Cash is building up on the balance sheet again (and we know that is real). Margins are still superior for the business. All-in-all it still looks on the accounts like a better-than-decent business.

And I am still none-the-wiser about what makes this business tick, why its margin is so much superior to the competition and why the management have this odd capital allocation strategy where they do nothing for years whilst cash builds up and then pay massive dividends.

I am looking for readers - preferably customers of or competitors to Syntel - to explain what is really going on.

Because - to be frank - I just don't understand.



  1. No information, just a comment [used to work in outsourcing]:

    A price taker with no scale, going up against much bigger players: fishy

  2. probably nothing but noticed they husband/wife team sold some shares in TPHS this week in an odd transaction. It's a post-reog NYC real estate dev co. They have a stand-in on the board.



  5. I can't help you with Syntel specifically, but maybe I can give you a pointer on your research. I doubt, personally, that you were wrong. The cash distribution maybe an instance of "taking Peter's money to pay Paul" or "hide the pea." I suspect that if you focus your research on the culture of the countries that those "funky"companies are domiciled in you might be closer to an explanation.

  6. Hey, dont know if you know, but in India we can access documents that a privately held / public company submits to the Registrar of Companies. The ROC website is superbad, but this website: is very helpful.

    I have used it often to find details of associates of indian listed companies, etc.
    Hope its useful.
    The new Tofler+ feature is also quite useful.

  7. Very few and concentrated customers suggests lumpy and somewhat unpredictable growth. Lack of a significant sales effort means very low sales expenses and higher margins. Frugal company run almost as a family run entity. Nothing all that exciting to analyze but just a buncha penny pinching cheapskates so all good employees leave as soon as they can - hope this connects the dots for you. -vik

  8. How do you know they paid out a billion dollars? If the founder owns two-thirds of the stock, he may have only paid out one third of the billion. Prima facie this does not make sense but if there was really only a few hundred mill of cash in the company and management wanted to bump the share price it might make sense. I agree it does not make a lot of sense but it worth thinking about.

  9. You can actually fake a billion dollar cash dividend if the founder and major shareholder with two thirds of the stock is on it - just pay a real dividend to the one third of holders not in on it, and well... just forget to bank the cheque on the other two thirds held by the founder (or make "special" arrangements for the founder to get their dividend and never even issue the cheque in the first place)

    et voila you've "paid" a billion dollar dividend for the real cash cost of $333 million.

  10. I'm a fund manager who bought the stock 3 months ago. I noticed the same red flags: super high margins, auditor without a brand name, offshore location of the finance department, etc....but I had the advantage of seeing the huge cash dividend paid before I stepped in. So I shrugged off the concerns.

    I asked the company how margins could be so high. Their response, "We have always managed service delivery very efficiently. Our senior executives for the most part are based in India. We pay our executives in rupees." Admittedly it wasn't a complete answer, and that is not unusual for this team--they do not seem promotional like most executives, so it can leave investors feeling unsatisfied. This was on full display in yesterday's earnings call, when 3 different analysts asked the same reasonable question about why Syntel was less optimistic about Financial Services trends than peers, and all they offered was "macroeconomic uncertainty." I don't think they really care to spin a tale that investors can attach to.

    Regarding the margins, my conclusion is that Syntel operates with a culture of thrift. They don't pay their executives aggressively, and they spend less on marketing. The smaller sales budget is likely what is causing their subpar revenue growth. I think they got away with being thrifty on SG&A for several years because their top customers (AMEX, State Street, and FedEx) were growing spending at a solid clip. So Syntel was able to approximate industry average revenue growth without the marketing budget. That has come to an end. Yesterday, they said they were going to start lifting the marketing budget, which will crimp margins a bit in 2017. Projected margins are right in line with Infosys.

  11. I wonder if there is something more nefarious going on given the higher levels of corruption inherent in India. Perhaps Syntel is a means for customers to "wash" money. I think if you speak to a few of their larger customers and ask why they contract with Syntel when it seems to be the more expensive outfit, then you'll have your answer?


  12. Indian IT outsourcers are notorious as a group for their very high turnover rates, so I think you can cross that red flag off your list.

  13. My question is why not take it private and not have to deal with the costs of being a public company and the short term thinking of Wall Street? The founders received the same dividend as everyone else so they must be flush with cash. Marketcap is only $1.5Billion so even at a takeout premium things are still reasonable. Debt is cheap and with the cash flow the company generates they can pay off the any debt incurred pretty damn quick.

  14. John, great to see you get back to writing about companies and shorts.

  15. A significant LinkedIn presence of ex-employees tagged as working in other, more or less legit companies would be a good sign in my book: while it's trivial to maintain a sockpuppet cadre of "workers" I imagine it's much harder to have them "change jobs" and not eventually cause some ruckus at that other, real companies with their phantom appearance.

    Maybe try contacting these ex-employees, they might be able to tell some kind of a story.

    Best regards,

  16. As has been highlighted above, they have high customer concentration and therefore, have historically spent a lot lower on Sales & Marketing (see the difference in CTSH vs INFY or TCS for example to see difference in Sales & Marketing and margin management). They also had some highly profitable clients (or maybe one) where the work was transaction processing in nature- so a very high-quality process outsourcing contract where margins can be high.

    Structurally, vendor consolidation and competition at top accounts is challenging revenue growth. Larger firms are mitigating this by adding new clients or shifting nature of work to new areas (vaguely called "digital") --> Syntel will have to invest to do either and hence, margins are unsustainable.

  17. Maybe they're just exceptional at what they do. If there were some secret sauce to their success - one that could be articulated in a blog comment - I imagine it could be replicated reasonably easy by Syntel's competitors. Assuming their capability to extract higher margin is true (and not as a result of fraud or otherwise unethical, unsustainable behaviour), my bet is that that is a capability embedded into multiple facets of their business.

    Maybe the inability of others to discover, discuss and replicate the nature of their expertise is a testament to just how good they are.

  18. The business doesn't require capital. These owners don't understamd products or capital allocation. If they hired offices and hardware they wouldn't need much capital at all. TCD uses about 10000 dollars fixed capital per person and about 7500 dollars working capital. I guess all the companies. Ate figuring that no point raenjng near zero returns in the co. If they try yo invest in other biz they will be punished. So likely that they are setting up/ expanding the large family office. They were most likely plqjn thrifty in costs.

  19. Syntax expects 2017 revenue of $900 million to $945 million and earnings per share to be in the range of $1.75 to $2.00.

    In the 2016 Q4 earnings conference call they anticipate operating margins will be in the 24% to 26% range.

    So taking the lower end, 24% of $900 million is $216 million. With a tax rate of mid 20% and 8 million interest payment that's about $165 million net income, or 1.96 EPS

  20. I believe that they are simply frugal and don't pay execs much in comp, which IMO is a good thing overall. One person said of Carl Icahn that 'he doesn't pay his employees spit' - but it hasn't really hurt his performance too much - you could argue that overpaying execs just makes them fat and lazy.

    They recently canned the CEO, likely due to poor performance I assume. I researched Desai and believe he is honest. He also has a ton of stock, which makes him motivated every day.

    Regarding 2017 headwinds, likely a lot of this is due to uncertainty regarding the transfer of power in DC and what that will mean for financial institutions / health care cos, which are large SYNT clients. Once the uncertainty passes, I expect SYNT's growth to resume.

    I am down about 20 percent on my SYNT long position - could be a good buying opportunity for the long run - but it appears that I bought too soon [and hopefully doesn't indicate my long thesis is broken].

  21. Does anyone know the reason for the sell-off in the last couple of days?

  22. Heard from my friend that works in India for the biggest PE fund there that Syntel is unlikely to be a fraud. Pretty legit according to him but the business itself is not that special...the key to their success are a few large lucrative contracts and lean operations.

    For example, their JV with State Street is supposedly a very high margin contract.

    Also, many outsourcing firms tend to do a lot of M&A as a way to acquire technology/clients. Syntel's m&a activity and therefore amortization on IS are almost zero. Makes their ROIC higher.

    I think there is a significant risk that future margins will be lower. And, it would be hard to sell that business at a higher multiple. Syntel's lucrative deals depend largely on personal relationships of the husband and wife team with their clients. They are in their 60s now, and they don't have anyone that can take over the business.

  23. Someone commenting said Auditor without a brand name? Crowe Harwath is quite a reputable name compared to the other Auditors used by Indian firms. That should not be a basis for shorting this stock.

    John, Their edge is simply the relationship with existing clients. They have a core group of clients, it doesn't seem like they add much. This enables them to keep the marketing spending low and also allow higher offshore vs onshore component and keep the margin relatively high. This is not something that is scalable or sustainable over a long run though I am surprised how long it has run. Indian IT companies are all mostly sitting on cash and it is a bit of a conundrum for them. This company had been thinking of dividend for as far back as 2012-2013.

    The business itself generates a lot of cash (you can look at any IT company) and most are debt free. Acquisitions have not gone too well and most savvy investors consider an acquisition as a waste of money. Paying dividend is tricky because of the tax leakage. These companies with cash in India & listing in US will not find it easy to repatriate money and then buy back shares. Offshore cash and its use has been tricky for everyone including Apple and Google. You can get around this issue by borrowing money until you come to conclusion that there is no possible use of this money sitting offshore.

    The IT industry had a great time but the market seems to be maturing now and almost all are sitting on a lot of cash. Difficult to short a Company in this industry in such an environment. You need much more solid thesis and convincing arguments. It seems more like you wanted to short and made up the arguments. Am also surprised about the turn from short to long.

  24. John - this is a blatant fraud and about as obvious as they come.

  25. John

    THe 60 minutes article on H1B visas in the last two weeks (march 24th now) where american workers are being asked to train their (indian) counterparts in order to get their severance cannot help the business model. I like you believe the numbers stack up, cash doesn't lie as they say, but its possible the company, being smaller then peers, may bear the brunt of H1b visas being tightened interested to hear your thoughts. Thanks for posting

  26. John, I did meet the founder once. My gut feel was he is of the same ilk that pretty much own the motel business in the US practicing extreme frugality. He got into the outsourcing business a long time ago and has probably delivered what he said he would, matter of fact, no flash, conservative and with no taste for the toys and bling that great wealth can buy. I don't know whether this is a long or short but I doubt very much that management is corrupt. I could of course be wrong but I doubt that very much.

  27. Results out today. Odd that they do not provide a cashflow statement

  28. Regarding the odd capital allocation - they recognized a huge one-off tax expense during the year they paid dividend. Indian dividend repatriation tax is 20.358% per their 10-K, which means they have incentives to delay this repatriation and keep searching for ways to bypass the tax, opportunistically, and re-investing the cash in operations/M&A during the interim. Eventually they gave up the search in 2016 and it was a bad performing year anyway, so they recorded and paid the tax.

    Need to think like an Asian family-owned business. If you can have the cash remained at the business, basically under your full control, why do you want to pay the cash to government?

    So why 2016? This article will give you the answer. 10% additional income tax from 2017-2018 tax year. In this regard, distributing a huge chunk in 2016 was really in the best interest of shareholders.

  29. @L' - can you please explain why the increase in Indian tax rules of 10% effective from 2017-18 will incentivize Bharat Desai to pre-pay himself? Does he get affected by Indian tax changes, I would have thought that he and his wife are US citizens and will file tax in the US. Correct me if I am wrong, which I am quite often.

  30. @Anonymous - didn't research deeper but dividend tax on Indian companies should be levied on all investors of Indian companies, likely a withholding tax.