Maruti Suzuki, investors’ stand-off over Gujarat plant to continue

Expect more fire and brimstone on Maruti Suzuki India Ltd’s (MSIL) decision to let its parent Suzuki Motor Corporation to float a subsidiary to invest in the upcoming Gujarat manufacturing facility. As the standoff between MSIL and its institutional investors continues, rumblings of a split in the company’s board of directors have surfaced.

The company’s institutional investors, in their recent second missive to the Maruti board, have escalated the matter by questioning how the independent directors on MSIL’s board had approved such an ‘oppressive transaction’ and whether they had evaluated all other alternatives before terming the present one an attractive option. Terming the decision as ill-conceived, they have urged MSIL to reconsider its decision and pursue the Gujarat project on its own. This letter is believed to have put immense pressure on the independent directors who are reputed professionals.

The next two weeks are expected to be crucial in deciding whether Maruti decides to climb down from its firm stance on not investing in the Gujarat facility, even as it prepares for a longer battle. Industry experts say that the negative sentiment reining the capital markets on the issue will not impact the carmaker’s cash reserves or earnings but the company’s market cap will definitely take a beating.

Will the matter now require the intervention of the government of India, market regulator SEBI, or the apex courts to draw the impasse to an end?

Even though independent directors’ opinions may differ on the decision, they will eventually have to fall in line as MSIL will not entertain differing views in its board. The Indian government, which has sold out its share in MSIL to Suzuki, Japan, cannot put any pressure on majority owner Suzuki (56 percent) which is a private limited company unlike MSIL that is listed on the stock market. SEBI, at the most, can technically only ask MSIL to reconsider its decision but cannot make it alter its decision.

The only two contributors to a likely reconsideration by Maruti Suzuki could be the loss of brand image and market cap or loss of favour with investors. Investors, despite their unhappiness over the issue, will not offload their shares as MSIL still maintains its status quo of being the most profitable carmaker in the country. However, if this decision is followed by other such unfavourable decisions for institutional investors like LIC or mutual funds, then they might resort to offloading their shares which would affect the share price of the company adversely. 

Speaking to Autocar Professional, Mohit Arora, executive director of JD Power Asia Pacific, says: “In terms of investments that they are planning to bring in, it is typically something that an OEM chooses, depending on what is the most cost-efficient option available. Of course, Suzuki needs to realise that if investments are driven by a local entity, which may have local ownership, its interests need to be safeguarded from a goodwill perspective and a fairness perspective. Eventually, the decision because Maruti Suzuki is a majority ownership of Suzuki can be decided by Suzuki in terms of what is the most cost-efficient vehicle for investment into the new plant. India is a fairly dynamic country and Suzuki must also be discovering it right now. It is just not possible to ignore the minority stakeholders. I think it is still too early to pass the verdict. It is something that they plan to do but I am sure they have heard the resentment that has come up in the country. Understanding that India is a very strategic market for that manufacturer, I am sure there are people who are listening.”

Meanwhile, due to the stoic silence maintained by Maruti on their first missive, the minority investors have in a follow-up letter (on March 5) penned their grievances, raking up a similar situation created in 2004 by Suzuki. Citing that instance, they have stated in that letter (a copy of which is with Autocar Professional) that the board of directors of Maruti Suzuki and the Indian government’s intervention had shot down the proposal. At that time, Suzuki Powertrain was also formed for manufacturing diesel engines for MSIL and was subsequently merged with the carmaker.

Investors have instead asked Maruti Suzuki to float its own subsidiary for the Gujarat project, else they could seek legal remedies as they hold adequate equity share capital in the company to do so.  The matter has already reached the market regulator SEBI and MSIL is believed to have explained its stand.

Avinnash Gorakssakar, head of research, Miintdirect.com, says that the new Gujarat plant will reduce Maruti Suzuki to a trading company and at the most it would get a trading margin of 6-8 percent from sales of the cars manufactured there. The bulk of the benefit would accrue to Suzuki as it holds the controlling stake of 56 percent in MSIL and the capex has been made by the parent company.  The main value addition to Maruti would be from earnings through investments in the capital market. These earnings would be minimal as its image would be of a trading company.

The Gujarat plant will manufacture all the new car models, which would be the volume and revenue earners going forward. Moreover, being in close proximity to Mundra Port, expect cars to be shipped abroad in large numbers. After a 2-3 year gestation period, the Gujarat facility would stabilise and start generating large profits from FY’16 onwards. MSIL’s Earnings Per Share would then have generated a minimum 15-16 percent earning for the shareholders with large value additions to the bottomline as well. The recent excise duty cuts are also expected to boost demand after one or two quarters. New model launches would drive profits, becoming a money spinning business wherein shareholders would also have struck large earnings.

An alternative to a subsidiary was the option of a buyback of shares at a high premium that would have pushed up MSIL’s share price. Maruti Suzuki is one of the most profitable businesses of Suzuki globally and reducing it to a trading company is expected to curtail its long-term growth.

“So the decision is difficult to digest as there is no value addition to the topline or profitability of the company,” adds Gorakssakar.

Investors have voiced their fears that the decision of the Maruti Suzuki board to allow Suzuki Motor Corp to implement the Gujarat project through a 100 percent subsidiary will convert MSIL into a shell company over time. This would not be in the best interests of the company’s shareholders.

The issue of royalty payment by MSIL to Suzuki, which is around 5.7 percent and considered very high, is another bone of contention. The investors’ argument is that it is paid on the entire value of the car when a large part of the car’s value is made through bought-out components.  

While asserting that Maruti Suzuki has built large cash reserves over the last 10 years, some rumours are also doing the rounds that the carmaker plans to invest in realty for its dealerships, in financial instruments in India and in factories of Suzuki overseas.

Market expert Sandip Sabharwal terms it as a strange decision, especially when Maruti Suzuki is believed to be sitting on a cash surplus of over Rs 7,000 crore. If MSIL had been debt-ridden, Suzuki’s investment in it would have been logical. However, despite all the company’s clarifications, Suzuki’s investment in the Gujarat plant is not cutting ice with investors.

Given the recent excise duty cut, interest rates after peaking are expected to moderate and Maruti has a good line-up of new models which would step up product demand – all positives for growth over the next two years. Against this backdrop, investors see the investment by Suzuki as a spanner in its growth curve and this lingering uncertainty will continue till production starts in Gujarat. If the company does well and its profitability improves over the next 3-4 years, only then will these concerns recede into the background.

So why is then Suzuki going ahead with its Suzuki launch vehicle?

Low-cost production advantage through economies of scale is believed to be an important reason. Manufacturing costs in Japan and globally are high and the Gujarat facility with its proximity to Mundra Port offers big export potential at low logistics costs. Besides, availability of skilled manpower at 25-30 percent cheaper rates due to the option of hiring temporary workers at lower wages than those available globally combined with lower overhead and medical costs will further make the end product cost- competitive. So it is not rocket science that as cost arbitrage improves, Suzuki’s profitability spirals.

RC Bhargava, chairman of MSIL, when broached on the subject, told Autocar Professional that one of the reasons why the carmaker is not investing in the Gujarat plant was because it wants to strengthen its distribution and marketing infrastructure in view of the future growth envisaged in India. 

“Today we sell 1.1 million cars but when the Gujarat plant goes on stream we will be selling 2.5 million cars YoY. We cannot sell 2.5 million cars without a proper marketing infrastructure. Any cash surplus of the company will be used in the best way for strengthening the network and in investments. We are looking at it at present. Regarding setting up of assembly facilities overseas, Suzuki has given up territories in Africa, Middle East and neighbouring countries as well as in Latin America to Maruti Suzuki as it will be more advantageous to the brand. The profits from sales through these assembly sites will come back to Maruti Suzuki in India.”

Abdul Majeed, head - Automotive Practice, PwC India, considers lack of clarity in the information conveyed to shareholders by MSIL on the Gujarat subsidiary as an irritant. “Big investments are required to keep the industry momentum and to keep the company’s market share intact. This requires out-of- the-box thinking that is currently not happening. There are many countries where growth is happening, so one has to consider how to produce more cost effectively. From the common man’s perspective, the benefit to both parties has to be communicated and the basic calculations have to be put in front of them.”

This calculation relates to the number of jobs that will be created over the next 10 years with the new project. At the same time the government has to put forth a clear roadmap of the fuel policy for the next 5-10 years to facilitate vehicle manufacturers to plan their investments accordingly. A scrappage policy to ensure polluting vehicles don’t ply on the roads, a vehicle replacement policy specifying age limits for vehicles as well as modernisation of labour laws for the manufacturing sector are the need of the hour.

The government’s interest is today skewed towards the services and agriculture sector. It is time big-ticket investments in manufacturing get a boost.