Maruti Gujarat Plant issue – corporate governance

Maruti Suzuki announced in January end that its Japanese parent Suzuki Motor Corporation (SMC) would invest $485 million in a wholly owned manufacturing facility in Gujarat to make cars and other vehicles on contract for sale by its listed Indian subsidiary. This move created discomfort with its minority investors and initiated a chain reaction which is now seen as a milestone event in domain of corporate governance in India.

Case facts:

The Japanese automobile company Suzuki owns 56 per cent in Maruti Suzuki India, i.e. it owns majority shares.

The plant would be established under a new 100 percent owned subsidiary called Suzuki Motors Gujarat Private Limited.

Maruti Suzuki had acquired 1,190 acre of land in Mehsana district in 2011 for its expansion plans that would now be transferred to the parent Japanese company in lieu of an annual rental fee.

As per the deal worked out between the SMC and Maruti, the latter would buy cars made by its parent at cost price that includes royalty fees embedded into it.

Maruti generates a third of Suzuki’s global profits and its annual 11.5 million-unit production contributes around 40 per cent to the worldwide volumes of the parent company.

Maruti currently operates six in-house plants – three each in Gurgaon and Manesar – with an installed capacity of 1.75 million units.

In recent past, there have been cases of extraordinary violence and obstruction at both locations of Maruti plants in Haryana.

What is the case about (in simple, layman’s terms)

Suzuki holds majority shares in maruti suzuki company. So technically it does not require permission for taking critical decisions regarding the company. This is where corporate governance comes in. Corporate governance is all about ethics and transparency and small investor protection and such stuff. A point about maruti, or for that matter most major indian companies’ shareholding pattern is that promoters own majority shares but there are other significant investors called institutional investors. These investors include mutual funds, insurance companies, finance companies, banks, etc. Their holdings often run in hundreds of crores or 5 to 50+ percent in some cases. However, their say in company decision making in India, has been dismal. But, in the maruti case they have shown unprecedented initiative. They joined together, all 17 of them if i remember correctly, and wrote to the board of directors expressing deep displeasure. The company had to relent because this meant lot of bad publicity and also these investors were powerful to impact maruti’s debt raising capabilities and stock market performance.

What are the issues raised?

the creation of a wholly owned subsidiary when a partly owned one exists can lead to conflict of interest

tricky transfer pricing issues – now, it is being said that transfer at cost prices but who is to say they won’t jack up royalty fee in 100 percent subsidiary or fudge costing or for that matter , stick to their cost price transfer policy. As the company is not listed, this will hinder transparency.

in course of time the company will be reduced to a marketing unit selling cars produced by the wholly owned subsidiary. Investors feared that suzuki wanted to do this in all its future plants and hence turn maruti into just a middleman of sorts. This would mean that maruti loses its profitability and value slowly.

SMC interests are not at stake here. Any transfer of value, whether small or big, gradual or quick, would impact only the minor shareholders, largest being LIC,with 6.93 per cent stake.

Who wins – Maruti or Suzuki or both or none?

Maruti’s argument in favour of the deal – “Maruti would financially benefit from the interest earnings resulting from not investing its money in this project directly and have no risk involved. While the Suzuki subsidiary would sell vehicles only to Maruti at the lowest cost possible.”

Suzuki has major cash pile which earns measly (near zero) interest in Japan. By investing it here would mean a much better rate of return.

Maruti itself has Rs.7,500 crore of free cash idling on its balance-sheet, earning about half of what the company earns as return on its capital employed.

Suzuki appears to be going down the same route as many of the other multinational corporate in India. Several MNCs in India have parked their most profitable businesses lines in 100 percent subsidiaries (ex – hyundai or even toyota, where kirloskar holds nere 11 percent and toyota 89): the listed companies either house the less profitable businesses or operate as marketing arms of the 100 per cent subsidiary.

The long-term plan (post fiscal year 2017) is to expand to up to 1.5 million units a year, which is about the current size of Maruti.

what happened after series of negative media articles and angry letters from investors

SMC has now watered down the proposal and also said it will seek the consent of the minority shareholders as envisaged under Section 188 of the new Companies Act.

Should the contract-manufacturing agreement between the two end, the plant will be transferred to Maruti at book value and not fair market value, as was first decided.

some terms explanation in layman friendly language –

Fair value is a value determined by each party as per their utility and then agreed upon by both or all parties. In maruti case, this would have essentially meant getting as much price for the plant Suzuki could extract from maruti as suzuki is majority owner but only a part owner. also company is Indian, so it makes sense to divert profits towards suzuki from maruti.

Book value is based on actual cost incurred minus depreciation. There are prescribed rules for determining this and major manipulation cannot be done easily.

Transfer pricing is the price charged by one part of organisation to other part of organisation. Ex – this is imaginary scenario – tata manufactures steel which is used in its cars, if the steel unit gives this for free also, there would ultimately be no overall loss for the tata group. But in reality these companies are separate entities. So must charge for the steel. Now if ratan ji or now, cyrus ji wants to decrease profits of tata motors he can simply charge very high for steel and if he wants lower profit for tata steel, charge super low for steel to motors whose profits would then shoot up. This kind of disgusting manipualtion is legally possible and rampantly done in power sector to dupe consumers. Reliance in delhiis doing this.

Some FAQs

1. You said that fair value is the agreed price between parties. In the present case, then how come Suzuki gets the authority to dictate price on Maruti? If Maruti didn’t accept that price, the fair value (as per the definition mentioned by you) stands nullified. Even if SMC mandated it in a clause, it cannot then be called fair value…

2. A small doubt in your transfer pricing example. Even if Tata steel inflates or deflates the price of steel while supplying it to another Tata firm in the same country, the profit/loss in its balance sheet will be reflected as loss/profit in the other’s balance sheet. The overall profit/loss of the entire group (Tata Sons) would be the same. Isn’t it? So what is the use of it? Unless transfer pricing is done to divert profit to a daughter company in some other country where tax rates are negligible, there isn’t any real profit… pls. clarify in the present context.

3. I also read that after the opposition, SMC will take consent of minority shareholders before establishing the plant. Does that mean that if minority shareholders are opposed to the move, the plan will be dropped? Despite SMC being a majority shareholder?

4. How would MSIL lose its value over time… can you please elaborate?

5. Is it because of labour issue ? Are the working labour norms more relaxed in gujrat than in hayana?

Answers 

1. Suzuki has majority control of maruti, so in effect any price dictated by parent will be accepted without question by maruti.

2. Yes you are correct, profits are flowed to companies with lower tax obligations, in many cases to several shell companies where they inflate expenses to neutralize the profits.
In maruti’s case i have mentioned the reason for keeping profits with parent company. Firstly, since it is only a partial owner in maruti , it would have to share those profits with others. But more importantly, they cant plough back profits from maruti to parent company easily but from suzuki, its pretty easy. In short, itna samajh lo agar maruti kamaegi to kharbuza katega aur sabme batega aur agar suzuki kamaegi to sirf wo company ke investors sitting offshore.

3. The statement clearly says that ” even though legally not obligated to do so, they will stop if minority shareholders
oppose”. another major point here is the new companies act which has a provision for asking minority shareholders opinion but since it has not yet come into force, the decision was taken by the company in a hurry. Now, it seems they are, for all practical purposes, bound to the clause.

4. Msil loses value slowly as profits will reduce as they would be cornered by suzuki as they keep increasing production of gujarat plant, with all new models coming out from there. One expert i talked to told that they will even close shop in gurgaon in next 10 years or so.The long-term plan (post fiscal year 2017) is to expand to up to 1.5 million units a year, which is about the current size of Maruti. A Barclays Research report says that post-Gujarat, there would be a structural change in the earnings profile of the company towards higher proportion of distribution margin. Note that in fiscal year 2010, Japanese parent Suzuki Motor Corp. had raised royalty from 3% to 5% of sales.

5. Though on the face of it, it may seem the move is mainly due to labour issues but in reality it goes much deep.
It is not about law as such, cuz law is pretty much same level in guj but the admin here cares far less. Most workers in guj are not very well organized, less unions, not considered large united vote bank. Many come from other states like bihar, up, rajasthan, maha, mp, etc.
Believe me, if all goes as per plan for suzuki, and their market share remains above 50 percent, they will reduce maruti to the marketer/distributor status. Similar to what happens with consumer goods giants like lg, samsung etc and their regional distributors.

sources – my own views (as mentioned in one forumias discussion and otherwise), prominent newspapers like ET, Mint, Hindu.