Maruti's Gujarat Plant Deal


March 11, 2014 

Second letter seeks to know whether Suzuki forced decision, questions high royalty payments

More of Maruti Suzuki’s institutional investors have joined forces against what they term as a blatantly wrong and value-eroding “oppressive transaction”, which will convert the auto maker into a “shell entity”.

Seven mutual fund investors in Maruti Suzuki, who had earlier written to company Chairman R C Bhargava about their concerns over the deal, have now been joined by nine other institutional investors, including five insurance companies.

Seeking scrapping of parent Suzuki’s plan to build a fully-owned factory in Gujarat, the second letter to the Maruti board in as many months said Suzuki would own the factory with production being earmarked for the local unit as this would shield it from the need to lock up its own funds. The shareholders said they failed to see how the deal, which would convert Maruti into a shell company over time, would benefit the Indian automaker.

The letter dated March 5 said, “We wish to remind you of your fiduciary duty and urge you to carry out the Gujarat project under the ownership of MSIL”.

The insurance companies that have signed a second letter against the move include HDFC Standard Life Insurance, Reliance Life Insurance, SBI Life Insurance and Birla Sun Life Insurance.

In January, MSIL board cleared a complex proposal to set up the new flagship plant at Gujarat through a fully-owned subsidiary of parent Suzuki Motor Corporation and not through the Indian listed company. MSIL, in turn, would buy cars from the newly-formed company at cost.

The second letter follows an ‘unsatisfactory response’ by Maruti to the initial letter sent jointly by top fund houses. The letter asked if the proposal had come from Suzuki or if they had considered alternatives to see if it was truly the best possible deal for the company.

“Please let us know as to whether the board invited such a proposal or if the board merely accepted an unsolicited proposal made by Suzuki. Further, please confirm whether the veracity and validity of Suzuki's proposal was benchmarked with other alternatives/market rates in order to arrive at a view that the proposal was the best option...” said the letter. It also added that the press release following their first letter did not address all their questions and only served to reinforce their adverse opinion of the company’s decision.

In the first letter that ran into seven pages, fund houses had analysed in detail how the Gujarat plant proposal was ‘ill conceived’. The letter had also raised concerns on cash flows, incremental capes and high royalty payments. “Maruti has received our second letter. The press release answering the first letter wasn’t satisfactory. We will wait for a few days for another response,” said a fund manager, who didn’t want to be identified.

In the fresh letter, fund managers have once again asked the company to reassess the royalty payment structure. According to consensus estimates, over the next three years, Maruti will have to pay around Rs 8,500 crore of its Rs 22,500-crore pre-royalty operating profit to Suzuki as royalty, they say.

Over four years to 2012-13, parent SMC received Rs 7,000 crore (5.7 per cent of sales) as royalty. The pre-royalty operating profit (excluding non-operating other income) over the past four years totalled Rs 18,800 crore. This implies a royalty payment of nearly 40 per cent of operating profits. Additionally, Suzuki received Rs 550 crore as dividends.

Fund managers said while the concept of royalty was justifiable, a big component of the value of car comprises bought items like bearing, batteries, etc. On these, vendors are either already paying royalty or incurring expenses on research and development or both. So, it is not fair to levy royalty on the total sale value of a car, as royalty should ideally be levied on the value of a car’s net of bought-out components. Further, fund managers say, royalty should be linked to absolute sales and the percentage should come down as sales increase.

According to the latest available data, fund houses together have an exposure of more than Rs 2,500 crore to the MSIL stock, which is more than 10 per cent of the free-float market capitalisation. Institutional shareholders have expressed their decision to use their shareholding to continue opposition to the decision.

“Since the last time we wrote to you, many other shareholders have endorsed and reiterated the sentiments expressed in the earlier letter and we collectively represent adequate ownership of the equity share legitimately oppose these decisions...” they said in their latest missive to the company.

Shares of Maruti Suzuki had declined over 13 per cent after announcing the Gujarat plant proposal, eroding value of more than Rs 5,000 crore. The stock has subsequently recovered has is back to the levels it was trading before the deal was announced.