SMGPL will manufacture vehicles and engine components exclusively for MSI cars, which will then sell them at home and overseas. The decision, approved by the MSI and SMC boards, sent the Maruti stock reeling and it lost 8.12% to close at R1,563.20 on the BSE.
Analysts questioned the rationale for housing the manufacturing operations in SMGPL and were apprehensive Maruti Suzuki may not not get the vehicles at the best price. Although SMC says the vehicles will be sold at cost, we are not sure what kind of margins the listed entity will make, said an analyst with a foreign brokerage.
Kotak Institutional Equities said the contribution margin on the sale of vehicles from Gujarat will be significantly lower than current margins, though the return ratio will be higher as Maruti would not be making any capital expenditure.
Proxy advisory firm IiAS observed that Suzuki appeared to be parking a profitable business in a 100% subsidiary, adding that the minority shareholders should have been allowed a say.
Suzuki will fund the first phase of the Gujarat plant and Maruti will indirectly fund the second phase, through the price of the cars purchased. Yet shareholders of Maruti will not have an equity stake in the Gujarat entity, which will continue to be 100% owned by Suzuki, pointed out IiAS.
In 2007, Suzuki had set up Suzuki Power Train to supply engines to Maruti Suzuki; the firm was recently merged with Maruti Suzuki.
Maruti Suzuki chairman RC Bhargava said both the Indian subsidiary and parent Suzuki would benefit from the new structure. Our funds will not be invested in Gujarat so we will not be taking on the risk associated with capital expenditure. The money will available for marketing spends and R&D and we can also earn 8.5-9% returns if we invest it, Bhargava said. Maruti Suzuki has cash reserves of about Rs 7,500 crore, while parent SMC has about Rs 25,000 crore.
Explaining the rationale for the move, Bhargava said Maruti had become a very important part of Suzukis profits and volumes. Suzuki sees strong potential in India and wants to be involved because there is a lack of investment opportunities in Japan while interest rates are also low. By investing here Suzuki gains from the increased sales of Maruti Suzuki as it gets 56% of the profits, Bhargava said.
SMGPL, the new Suzuki subsidiary, will sell cars to Maruti at a price that includes no profits but just the cost of production and adequate cash (net of tax) to cover incremental capital expenditure requirements, according to the agreement between the two companies. The return of investment for SMC would be realised through the growth of Marutis business. We expect the benefits to start coming by 2018. We will double our return on capital - while Marutis own production capacity will stay at 1.5 million, we will actually sell 3 million cars without having to bother about the manufacturing of the other half, Bhargava said.
Osamu Suzuki, SMC chairman, said that all three partners (SMGPL, SMC and Maruti) are expected to work together in a way that derives common benefits, while adding that SMC has no plans to increase stake in Maruti Suzuki. Maruti has reached 1 million annual sales and has to double its network now. In my experience, volumes are manageable till this point, after which you need a new company. Instead of SMC officials helping in expansion, I believe our Indian managers can do it best, he said.
Headquartered at Ahmedabad, SMGPL would be set up by April this year with a starting share capital of Rs 100 crore. It will be headed by N Aizawa, a senior Suzuki executive who will be deputed from Japan, while other senior managers are likely be deputed from Maruti Suzuki.
Production at Gujarat is expected to start by end-2016. SMGPL would initially invest Rs 3,000 crore for a 250,000-unit-per-annum production line, though at start the output would be 100,000 cars a year. In total, the two facilities in Gujarat in 640 acres in Becharaji and 550 acres in Vithalapur can accommodate seven production lines producing almost 1.8 million cars a year. Till date, Maruti has already invested Rs 250 crore in purchasing the two plots of land, which will now be leased to SMGPL on an arms length basis.