Investors feel that handing over a critical and highly profitable project to a 100% subsidiary of Suzuki instead of Maruti Suzuki is neither fair nor in the interest of carmaker and its about 44% minority shareholders

Several investors of Maruti Suzuki India Ltd (MSIL) have raised objections over the carmaker's proposal to enter into contractual arrangements for expansion with a 100% subsidiary of Suzuki Motor Corp (SMC). SMC is majority shareholder in MSIL with 56.2% stake. This is the second time in past 10 years SMC is trying to establish its own manufacturing plant in India.

The shareholders said they were concerned that the contract for the plant in Gujarat meant the Japanese carmaker rather than Maruti would reap the benefits of rising domestic sales, at a time when India is tipped to become the world's third largest auto market by 2020. Minority shareholders hold 43.79% stake in Maruti Suzuki.

Seven fund houses, including ICICI Prudential MF, Reliance MF and UTI MF, which hold 3.93% stake in Maruti Suzuki are planning to approach market regulator Securities and Exchange Board of India (SEBI) after the car maker failed to address their concerns.

Some of the prominent shareholders holding more than 1% of the shares as of 31 December 2013 are:
 

Mutual funds are opposing Suzuki’s move to make the proposed Gujarat unit its wholly-owned subsidiary as the deal would transform MSIL into a distribution company from a manufacturing one.

While SEBI is yet to hear officially from the fund houses, it is already looking into the matter on suo motu basis.

According to the new corporate governance norms, this deal can be construed as related party transaction requiring approval from public shareholders, but these new regulations are yet to come into force and would be effective from 1^st October.

Earlier, in a press release, the carmaker had said, "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 the investors, the initial installed capacity of the Gujarat Suzuki plant is for 250,000 cars per annum at an investment of about Rs3,000 crore. The final capacity of this plant would be 1.5 million (15 lakh) units. "Assuming a 15% CAGR for the Indian car industry, particularly give the low base of past few years, and a constant market share for MSIL, implies that the Gujarat plant will have to reach the 1.5 million cars per annum output by FY2021 itself," the investors said.

Number of vehicles (in million)

Source: Letter from investors to MSIL

Investors feel that the expansion of Gujarat Suzuki plant to 1.5 million by FY2021 implies an incremental capex requirement of additional Rs12,000 crore (assuming 20% lower capex compared with the first phase on a per car basis).
 

"If the cash flows of the Gujarat plant have to fund the incremental capex (as mentioned in the MSIL release), this implies that the initial investment of Rs3,000 crore by Suzuki in phase I will be valued at Rs15,000 over the next six years (FY15-FY21) at cost itself. This implies an internal rate of return (IRR) of nearly 30%."

"Thus, while Suzuki is not taking cash or dividends, and the cash flows are being utilised to increase capacity, the IRR on Suzuki's phase I investment is very high and much higher than the cost of capital of both MSIL and Suzuki itself," the investors said.

Investors of MSIL are also worried about fresh investment requirement of the Gujarat Suzuki plant. They said, "It needs to be noted that the capex of Rs15,000 crore for 1.5 million cars is only for assembly. Fresh investment may be needed in engine and transmission capacity once the surplus capacity in Maruti's existing facility in Haryana is exhausted, which can further potentially increase the IRR."

"Moving this critical and highly profitable project into a 100% subsidiary of Suzuki instead of MSIL is neither fair not in the interest of carmaker or its shareholders and will lead to significant erosion of value for MSIL shareholders," the investors said.

Similarly, Bengaluru-based InGovern Research Services also had advised shareholders of Maruti Suzuki, to vote against the country’s largest carmaker's proposal to enter into contractual arrangements for expansion with a 100% subsidiary of Suzuki, the dominant shareholder in the company.

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.

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.

Earlier, in 2004, SMC announced that it would set up independent manufacturing plants in India for diesel engines and two wheelers. At that time, the union government took a tough stand on the proposal of SMC to pump in Rs1,000 crore in India to set up a new company for car assembly with a production capacity of 250,000 units. The government had said that it would not allow any competition from the Japanese carmaker which would hurt Indian shareholders of Maruti. This forced SMC to call for a truce. This resulted in the Indian government getting 70% stake in the new venture with SMS holding the rest.