Has Suzuki short-changed Maruti

Written by Amit Tandon | RC Bhargava | RC Bhargava | Updated: Feb 4 2014, 08:53am hrs
Has Suzuki short-changed Maruti In a word, Yes. The announcement of the Gujarat plant has left Marutis shareholders with the short-end of the stick. Maruti is funding the entire capital expenditure and reimbursing the cost of manufacturing without having any shareholding in the company. Heres how:

* Suzuki Japan will bring in about Rs 3,000 crore to set up the first phase of production at Gujarat, which is being funded almost entirely by Maruti. In 2012-13, Maruti paid Rs 2,450 crore as royalty and an additional Rs 136 crore as dividend to Suzuki. Almost Rs 1,200 crore of royalty is accrued to Suzuki for the first half of 2013-14 sales.

* Suzuki Gujarat will invest in the first phase of capex. The remaining phases will be undertaken from the margin Suzuki Gujarat makes on selling cars to Maruti. Effectively, Maruti also funds the remaining capacities at Gujarat, and yet has no ownership of it.

* Suzuki Gujarat will pay Maruti lease rentals for the use of Gujarat land. Maruti will reimburse Suzuki for this lease rental through the cost of car manufacture. In effect, Suzuki will have free use of Maruti land in Gujarat.

Contrary to claims made in the announcement, it is financially more efficient for Maruti to invest in the Gujarat plant than Suzuki Gujarat. Maruti contends that Suzuki Japan is making the investment in the Gujarat plant because it has a lower cost of capital than Maruti. This means Maruti gets better returns investing its Rs 7,500 crore cash surplus in India than Suzuki Japan gets by investing its excess liquidity in Japan. But if Maruti invested its Rs 7,500 crore in the business instead of investing it in securities, it would get a much higher return, because Marutis RoI from core operations is much higher than its investment yield. Thus, Maruti shareholders lose out on the incremental returns that investing in core operations would generate.

The Gujarat plant announcement is just another action that Suzuki Japan has taken that is far more in its own interest than in Marutis. Suzuki Japan has steadfastly doubled its royalty payout percentages over a five-year period to its current 5.8% of net sales. The rate of increase in royalty (in rupee terms) is significantly higher than the growth rate of Marutis sales, PAT or dividend. If royalty had not been paid in 2012-13, Maruti would have reported double the profits and shareholders would have received higher dividends and, possibly, benefited from better valuations.

Marutis minority shareholders have been treated as mere bystanders by Suzuki Japan:

* Marutis board, in which 8 of the 12 members represent Suzuki Japan, has approved the Gujarat plant deal without any consultation with other shareholders. Interestingly, the announcement has come just two months before the new Companies Act 2013 comes into force, under which this transaction would need shareholder approval. Because promoters benefit from this transaction, it would need to be approved by a majority of minority shareholdersas was the case with the Holcim-Ambuja dealthus giving minority an opportunity to have a say.

* With the Gujarat transaction, the control over operations and cash flows has moved to Suzuki Japan. The balance of power, already in favour of Suzuki Japan, will now tilt completely towards them. Over time, Suzuki Japan could undermine the criticality of Maruti and significantly increase the importance of Suzuki Gujarat bringing in newer technologies, and expanding capacities: Maruti will soon to cease to have any control over its own destiny.

Maruti was christened as the bellwether of the new corporate India when it began operations in 1983. Its products were superior in quality and its manufacturing had a higher degree of automation that brought in greater product standardisation. Suzuki Japan inculcated respect for labour, and broke the class divide between management and staff by enforcing equality. The helped grow the auto ancillary industry and cemented Indias status as the global small car manufacturing hub. Then, Maruti was one of the most trusted brands in India. Today, it has lost its sheen.

The author is managing director, Institutional Investor Advisory Services India (IiAS)

Apprehensions have been raised on Marutis deal with Suzuki pertaining to the Gujarat plant. These are completely misplaced and the arrangement will ultimately benefit Maruti, and is not detrimental to the shareholders.

First, it has been said that Suzuki appears to be going the same route as many of the other multinational corporations in India. The argument is that several MNCs in India have parked their most profitable business lines in 100% subsidiaries, and the listed companies either house the less profitable businesses or operate as marketing arms of the 100% subsidiary.

This conclusion seems to have been reached without studying and analysing the Suzuki proposal and other MNC companies. The Suzuki subsidiary would only be a manufacturing company, and would not be selling its production to any one other than Maruti Suzuki India Ltd (MSIL). The price at which the sale would take place will only generate a surplus to fund the capex costs. No other profit will be made. Therefore, there will be no surplus for any purpose. The question of parking the more profitable products in the Suzuki subsidiary, thus, does not arise as the company would not be selling the products in the market. MSIL would realise the profits by selling the cars, including those made by the SMC subsidiary, in the market. Since these cars would become available at a price which does not include profit, other than for capex, the entire benefits would accrue to MSIL.

Also, all new product licence agreements would be signed between MSIL and SMC Japan, and royalties would be determined in terms of this agreement.

Then, it has also been termed as a significant strategic misstep pointing out that Marutis lack of control over production cost is a worrying factor and it may lead to risk of earnings deterioration and cash drain by Suzuki.

It is not correct to assume that MSIL would have no control or look at the costs of production. The contract manufacturing agreement, which has yet to be finalised, would adequately safeguard MSIL interests. It is not clear what is meant by earnings deterioration and drain of cash by Suzuki. This needs to be amplified and explained.

Other apprehension is that the move raises questions on future strategies and it adds to the complexity and ambiguity of the ownership structurethere is no compelling business logic for such an arrangement when Maruti has necessary capital raising ability.

It is not understood how this arrangement creates ambiguity or complexity in the ownership structure. The Gujarat subsidiary will be 100% owned by SMC Japan, while MSIL is a listed company in which SMC has 56.2% equity. Contract manufacturing is widely practised. For example, Apple, the worlds most valuable company, gets all its products made under contract manufacturing arrangements. Those manufacturing companies make profits while SMC will not do so under the arrangement with us. MSIL itself buys out 70% of the value of its products from component manufacturers. MSIL has been selling cars to Nissan under a contract manufacturing agreement for three years.

By retaining charge of vendor relations at the new Gujarat car factory to be set up by Suzuki, MSIL will ensure that the cost of producing cars there remains on par with its own two plants in Haryana. The pricing of cars sold by Suzuki Motor Gujarat (SMGPL) to MSIL will take into account the cost of material, labour, electricity, depreciation of equipment and other consumables, but not include any profits.

The pricing of cars sold will be based on the contract manufacturing agreement.

The whole operation would involve close coordination between the two companies. We will be giving production targets to the Gujarat plant and pick up as many vehicles as they produce.

It is quite clear that there is nothing to worry about the arrangement and it will be a win-win deal for both MSIL and Suzuki.

The author is chairman of Maruti Suzuki India