Given that shareholders always want more, it is not surprising that Institutional Investor Advisory Services (IIAS) has put out a catchily-titled note—Royalty flows in Suzuki’s blood—arguing that Suzuki Motor Corporation of Japan is charging its Indian subsidiary Maruti Suzuki India Limited too much royalty. Over the past 15 years, IIAS says, royalty paid per car has grown 6.6 times while average sales realisation per car has risen only 1.6 times. In the last 5 years, IIAS says, Maruti’s profit before tax was Rs 16,770 crore while its royalty payment was Rs 11,870 crore—in FY15 alone, royalty expenses added up to a whopping 36% of Maruti’s profit before tax and royalty. Combine this with the fact that Maruti alone accounts for 40% of Suzuki’s profits, and it does seem like a royal rip-off.
One of the reasons for this given by Maruti’s management is that, with the royalties negotiated in yen, the rupee depreciation has added to the burden. Between FY09 and FY15, for instance, Maruti’s royalty-to-sales have risen from 3.3% to around 5.9%, or an increase of 1.7 times—the fact that the rupee depreciated by 1.2 times during this period is therefore a big factor in the increase in royalties. Which is why, Maruti has now negotiated a new agreement whereby, for new models produced after FY18, royalties will be paid in rupees—that, in a sense, is a tacit acknowledgment of the fact that IIAS has a point. While it is likely Suzuki will hike the royalty rates to take into account the exchange rate risk, the real issue is whether Suzuki, or other MNCs for that matter, is over-charging on royalty. IIAS argues that while Suzuki’s consolidated R&D spending is around 4% of sales—this includes motorcycles—it is charging Maruti royalty at around 6% of sales.
This is where the arguments being made are a bit one-sided. For one, given that motorcycles have lower R&D, it is very possible Suzuki’s passenger car R&D is around 5-6% of sales, a number not too different from the royalty Maruti is paying—indeed, that is also the R&D spending for most auto majors globally. There should, in any case, be no doubt that Maruti would not be the market leader had it not been for the technology Suzuki is supplying it—that is why, Maruti’s PAT margin has risen from 6% in FY09 to 7.6% in FY15, and that is after all royalty payments. Indeed, if Suzuki was ripping off Maruti to the extent being suggested, it is a bit odd that institutional shareholders, both foreign as well as domestic ones, have hiked their stake in Maruti from 23.9% in March 2010 to 30.1% in September 2015, or that Maruti’s share price has more than trebled in this period. Indeed, as our lead story argues today, while royalty payments by top MNC-subsidiary stocks have gone up by 15% (ABB) per annum to 34% (HUL) in the last six years, the stocks have appreciated by anywhere between 20% (ABB) per year to 44% (Glaxo). Which is why, in most cases, these firms are trading much higher earnings multiples than their local counterparts—though not strictly comparable since they are in different segments of the automobile market, Maruti’s trailing PE multiple is 35 as compared to 23 and 9 for M&M and Tata Motors, respectively.