The Rise and Fall of Subex Founder Subash Menon

Image: Mallikarjun Katakol for Forbes India

DOWN BUT NOT OUT Subex founder and former chairman Subash Menon accepts his wrong call on Syndesis but defends his strategy of inorganic growth

On September 27, 2012, two decades after he started the company and one day before his investors were to vote to extend his term as managing director and CEO for another five years, Subash Menon resigned from Subex. He had already stepped down as chairman a few months ago.

It’s normal to reward longtime employees of a company when they leave; and in this case, Menon was the company’s founder too. Yet, he wasn’t eligible for either the separation or the notice period amounts in his employment contract. Subex’s board had in July amended those contracts to first remove the separation payment, and then to prevent a notice period if Menon resigned on his own.

Within a week, Ramanathan J, head of the company’s finance function, resigned. Sudheesh Yezhuvath, Menon’s brother and the company’s COO, was removed.

The board that took these decisions was mostly new. Anil Singhvi, a former CEO of cement maker Gujarat Ambuja and founder of investment advisory firm Institutional Investor Advisory Services (IIAS), and Sanjeev Aga, former managing director of Idea Cellular, joined the board in April 2011 as independent directors. Both Singhvi and Aga are part of a new tribe of shareholder activists-cum-advisors, who are seen as a minority shareholder bulwark against the whims and fancies of promoters.

Two more board members were added this July when Surjeet Singh, former CFO of Patni, and Karthikeyan Muthuswamy, an investment advisor to Elliott Capital, were brought in as nominee directors.

On October 5, Singh was elected as Subex’s new CEO. He had left iGate Patni (now iGate Corp) in May 2011, reportedly after being denied the CFO’s role.

And so it happened that Subash Menon—entrepreneur, risk-taker, history buff and socialist-communist—found himself surgically separated from the Rs 477-crore Subex, a company he started with a loan of Rs 20,000 from an ex-employer in 1992.

His shareholding is down to just over 5 percent in Subex and the five-year-long rope his investors had given him has finally run out. Like with many entrepreneurs, his sheer ambition was simultaneously the reason for Subex’s meteoric rise as well as its catastrophic fall.

But if he’s dejected, he doesn’t show it. “The company is on a strong footing and it can now go back to its earlier rate of growth. To me, it’s a job done to a large extent,” says Menon.

The Perfect Storm
In the 1990s and 2000s, Subex challenged the conventional wisdom about creating software in India. It sold branded software licences instead of selling code by the kilo (or KLOC—kilo lines of code), ploughed back cash and equity liberally for growth instead of hoarding every penny of profit, and aggressively acquired foreign companies.

From 2000, its revenues grew at a compounded annual rate of 33 percent to reach $54.8 million by 2007.

Then, in January 2007, Subex bought Canadian telecom software company Syndesis, its seventh acquisition, for $165 million in cash. You could say that was the beginning of the end of Subex’s dream run.

It had first approached Syndesis for a merger in late 2005, but the company was not interested in selling. Ironically, in 2006, just a year later, Syndesis approached Subex offering itself for sale ostensibly because its investors—a clutch of venture capital firms, including the likes of Sequoia and Greylock—wanted an exit. But the deal would have to be done in cash, the entire 100 percent of it.

That was the first mistake because, in the past, Subex had done most major acquisitions using its own stock instead of cash.

For the first time in its history, Subex acquired a company for its IP instead of its customers. But because Subex’s expertise lay in a different area (revenue maximisation) than Syndesis’ (service assurance), it was unable to either fully understand the complexity of the latter’s software or poke holes in its rosy sales projections. That was the second mistake.

“Syndesis had negative margins. Venture-backed companies are not very profit-oriented. Their view is to get revenue up, achieve capital gains, sell and get out,” said Menon to Forbes India in an interview in September 2008.

Subex then decided to raise most of the money for the acquisition by listing its shares on the London Stock Exchange through the GDR (Global Depository Receipts) route. But on February 27, 2007, one day before its fund-raising roadshow was to end, stock markets around the world crashed following the lead from the Dow, which fell 416 points—its largest fall since September 2001. Subex’s stock crashed to Rs 620, lesser than the SEBI-set floor price of Rs 650 for its GDR.

Therefore, Subex was forced to drop its GDR issue and raise all $180 million through the foreign currency convertible bonds (FCCB) route. “We were cornered. Not only would we have lost Syndesis to another potential buyer we knew was waiting in the wings, but we would have taken a hit on our reputation. The next time we went for an acquisition, people wouldn’t believe us and would ask us to show them the money first and then come for a discussion. So instead of taking that hit, we went in for the bonds. We never intended to leverage ourselves like that, but circumstances forced us to,” Menon told Forbes India in April 2009.

That would be Subex’s third, final and perhaps fatal mistake.

“The irony is that I’m a firm believer of using equity for acquisitions. All of Subex’s six prior acquisitions were done using that even though investors and analysts told me I was making a mistake and should leverage. Up until April 2007, we were debt-free. But I got caught up in what is called the ‘deal momentum’ and opted for debt,” says Menon.

Subex’s $180 million worth of FCCBs issued in 2007 were to mature in five years when they would be paid for using fresh shares in the company with the assumption that the market price of each share would be at least Rs 656.

But that was not to be. Instead, its shares fell by more than half to Rs 350 in 2008, and to just around Rs 26 in 2009. The result is that Subex’s share base will need to expand from 35 million in 2007 to 380 million by 2017 for it to pay off all the debt. Its original projection was to only expand to 47 million.

Just like that, the Subex story was over.

“I had a firm belief, but I went against that. Jokingly, I’ve told people that I’ve proved myself right by doing the wrong thing. Nature sometimes colludes against you,” says Menon, without the slightest twinge of regret in his voice.

The Vultures at the Gates
On October 2, the Argentine Navy’s flagship, the 100-metre-long Libertad, sailed into Tema, Ghana’s biggest port. There, it was seized under judicial orders based on the request of US hedge fund NML Capital that said it was owed $350 million by the Argentine government on bonds that it held.

NML was a subsidiary of the $20 billion Elliott Capital Management founded by Paul Singer in 1977, which has delivered compounded annual returns of nearly 15 percent since inception, a remarkable feat.

But Elliott was what many people called a ‘vulture fund’ for its predilection to swoop down and buy debt issued by companies or even countries that are on a financially unviable foot and might default soon. Once in, these funds use high-impact legal strategies to extract multiple times their pound of flesh. It would turn out that Elliott Capital was one of the largest buyers of the $180 million worth FCCBs Subex issued in 2007 to finance its acquisition of Syndesis.

To paraphrase Humphrey Bogart from Casablanca, “Of all the hedge funds in all the towns, in all the world, Subex had to walk to Elliott!”

With Elliott as one of its largest bondholders, Subex would never have it easy. To compound its woes, in 2008, QVT Capital, another hedge fund that loves distressed debt situations, acquired a significant chunk of Subex’s outstanding bonds at a huge discount. There was no way Subex could have paid off its debt that was projected to balloon into $245 million by 2012. But Menon didn’t give up either.

In 2009, he managed to restructure Subex’s bond-debt by issuing fresh equity and by re-pricing the conversion price down from Rs 656 to Rs 80. This brought down the outstanding debt to $131 million. Then, this July, he restructured the debt by pushing back its maturity another five years to 2017.

While Menon was fighting to stave off the mountain of debt, Subex’s business was deteriorating rapidly. With all its profits being set aside to account for the growing mark-to-market losses on its debt, it didn’t have any money to invest in things like R&D and marketing.

The Syndesis business also came a cropper. Syndesis’ products were targeted at large wireline companies that wanted to roll out newer services like IPTV and faster broadband, a category that was hit hard by the global slowdown. “We acquired a set of products in 2007 but after the 2008 slowdown the world didn’t need those products. Customer requirements changed; the world had moved on,” says Menon.

In September 2011, Subex sold Syndesis to NetCracker for a price estimated to be somewhere around a tenth of its original purchase price of $165 million. “Clearly, the dilution happened and shareholders were hit. But the business didn’t close down and attrition was very low, right from the senior management down to even the second and third levels of it. Operationally, the company is on a strong footing. Yes, the debt is still there, but in five years the company could potentially pay off 60-70 percent of total debt on its own,” says Menon.

But his time had already run out.

Elliott and QVT had ended up with nearly 20 percent of Subex’s shareholding on account of their interest due on the bonds being converted into equity, and they saw no merit in keeping Menon on board. Menon’s own shareholding had fallen to just over 5 percent and is expected to fall further to just 2 percent upon dilution of all outstanding bonds.

Even Singhvi and Aga, the two independent directors, who Menon claims he invited on his board in April 2011 for their advice on how best to steer Subex away from its debt trap and into newer markets and product areas, apparently turned against him in less than a year, says a person who is privy to board-level discussions. The board, says this person, felt Menon had been unable to channel the software and telecom talent within Subex to come up with new product lines since the 2007 Syndesis debacle.

The board also felt that Menon had to accept responsibility for the acquisition that almost destroyed Subex. Menon accepts his wrong call on Syndesis, but defends his inorganic growth strategy. “Acquisitions are very critical in the software products space. You could lose five to six years if a product that you conceptualise and bring to the market is a failure, hence organic growth can’t be the only arrow in your quiver. Look at companies like Oracle, IBM and Microsoft—everybody acquires. In fact, if we had stuck to only organic growth, we may have remained a $20 million company, like most of our international competitors, even today. There would have been no Subex, at least of this size. So, the fault was not with inorganic growth but that we acquired the wrong company,” he says.

But another senior person at Subex felt Menon got caught between the dynamics of two powerful hedge funds who weren’t interested in long-term value investing and two independent directors who had their reputation to guard. “Singhvi and Aga seemed to have an agenda, and their board membership was only a means to position themselves. And what better company to do that than Subex, because of the drastic fall in their share price,” he says.

Both Singhvi and Aga refused to comment on this story. Detailed emails sent to nominee director Muthuswamy (who represents Elliott) and Subex CEO Singh went unanswered. Mansi Chouhan, a spokesperson for Subex, declined to participate in the story over a period of 10 days because Singh was travelling abroad to meet customers. “I have sent letters to SEBI and other regulators saying I’m not the promoter of Subex any longer,” says Menon.

He’s now the promoter and CEO of Kivar, a group of related companies he started in 2009, that will offer services in areas like municipal solid waste and water management, energy and infrastructure. Kivar Environ, the leading group company that is into municipal solid waste management, is already clocking Rs 100 crore in annual revenues. “Entrepreneurs cannot be pushed beyond a point. I created something out of nothing, I can create something else out of nothing,” he says.