Maruti Suzuki appears to have done a grave injustice to its minority shareholders by agreeing to enter into a deal with a 100% subsidiary of Suzuki Motor Corp, the dominant shareholder of carmaker, says InGovern

Bengaluru-based InGovern Research Services has advised shareholders of Maruti Suzuki India Ltd (MSIL), to vote against the country’s largest carmaker's proposal to enter into contractual arrangements for expansion with a 100% subsidiary of Suzuki Motor Corp (SMC), the dominant shareholder in the company. Japanese-based SMC holds 56.2% stake in Maruti Suzuki.

Acting on a proposal sent by SMC, the board of Maruti Suzuki has agreed to an arrangement according to which expansion and production of the company branded cars will be undertaken by a 100% subsidiary of SMC on plots of land the carmaker had purchased in Gujarat in 2011. The subsidiary will produce vehicles in accordance with requirements of MSIL and will be sold only to the carmaker. The price of the vehicles to MSIL would include cost of production by the 100% subsidiary and adequate cash to cover incremental capital expenditure requirements. The return on this investment for SMC would be realised only through the growth and expansion of MSIL’s business. The subsidiary will always remain a 100% subsidiary of SMC.

According to InGovern, this is not a simple contract manufacturing arrangement, as the dominant shareholder of MSIL is 'the contract manufacturer' and can dictate the terms of any contractual arrangement.

Image Source: InGovern

InGovern says, "Various contractual arrangements that give scope for conflicts of interest are:

(a) Transfer pricing of vehicles from 100% subsidiary to MSIL. The cost of production and adequate cash to recover the capital expenditure would be returned to the 100% subsidiary;

               (b) Lease rental on land, as land continues to be on the books of MSIL;

              (c) All assistance in executing the project to be provided by MSIL;

              (d) Ownership and development of newer products and brands;

              (e) Vehicular offtake."

According to the proxy voting advisory firm, the positives stated by Maruti Suzuki that the company benefits from the interest expense of not investing is not tenable as the carmaker is a net cash flow unit and incremental cash generated would be better utilised for capital investment for this expansion.

"There is no compelling business logic for such an arrangement when MSIL has the necessary capital raising ability to make investments. It looks like the SMC subsidiary will enjoy the benefits of no business risk with assured vehicle offtake by MSIL and assured return on investments, while MSIL will bear the business risk of cyclical vehicle sales, competitive pressures, pricing and cost pressures. Inventory levels, car pricing and discounts, cost increases, dealer network management, post-sale servicing, brand management  would all be risks  that will continue to be  borne by MSIL, while the 100% SMC subsidiary enjoys an assured vehicular offtake at pre-determined prices," InGovern said in its advisory.

Minority shareholders hold 43.79% of shares of Maruti Suzuki. Some of the prominent shareholders holding more than 1% of the shares as of 31 December 2013 are:
 

Image Source: InGovern

InGovern says minority shareholders of Maruti Suzuki should oppose this move, and register a compliant with SEBI. "They (minority shareholders) will have to be given a chance to vote on the contractual arrangements with the 100% subsidiary as the contracts are related party transactions. Suzuki as the promoter would not get to vote on such related party transaction. Shareholders should oppose and vote against such contracts.  Shareholders should also write to the Foreign Investment Promotion Board (FIPB) opposing any approval for setting up the   100% subsidiary," the proxy voting advisory firm said.

A Pliable Board

The Board of directors and independent directors, in particular, are accountable for approving such a transaction, and not safeguarding the interests of minority shareholders. According to InGovern, minority shareholders of Maruti Suzuki should be aggrieved as they continue to get short-changed by the company. It says, "The company lacks an independent chairman. Also, independent directors constitute only 33% of the Board. Although the composition satisfies the requirements of Clause 49 of the listing agreement, the outnumbering of independent directors by non-independent directors may be one of the reasons for the Board to lack true independence in thinking."

Image Source: InGovern

History of shortchanging minority shareholders

On 5 May 2010, the government of India amended the Foreign Exchange Management (Current Account Transactions) Rules, 2000, omitting the requirement for prior approval from Ministry of Commerce and Industry for royalty payments to technical collaborators exceeding 5% of domestic sales and 8% of export sales. On 13 May 2010, the Reserve Bank of India (RBI) correspondingly issued a notification permitting banks to release foreign exchange for making such royalty payments. Thus, regulatory requirements that capped royalty payments to foreign collaborators had been removed.

In July 2010, MSIL was the first multinational company that made use of this relaxation and disclosed that it had paid 5.1% of its sales for the quarter ended 30 June 2010 as royalty to its parent Suzuki Motor Corp of Japan. Thus, while sales increased by 27% year-on-year for the quarter, it was accompanied by a 20% fall in net profit year-on-year. To put the quantum of royalty payments into perspective, the royalty amounted to almost 64% of Maruti Suzuki’s pre-tax profit or 88% of its post-tax profit.

In July 2010, Maruti made a post facto disclosure of the royalty payments and the stock price dropped sharply by 12% on the day after the Q1FY11 results.

InGovern says, "Now in January 2014, yet again the Board of MSIL has demonstrated subservience to the dominant shareholder Suzuki. In agreeing to a proposal by Suzuki Motor Corp to provide assistance and expansion at a 100% subsidiary, the Board of MSIL has not demonstrated independent thinking and doing what is right for the carmaker and its shareholders."