Why Maruti's shareholders have a job on their hands

Minority shareholders of India’s largest carmaker Maruti Suzuki India Ltd are faced with a dilemma - they have to vote on a big decision that could have far-reaching impact on the future of the company they are invested in. They have to act in good faith, and hope the company does too. The month-long voting window will end on December 15.

The company has asked the shareholders to approve a proposal that allows its parent Suzuki Motor Company to set up new manufacturing plant where the investment would be routed through a new subsidiary Suzuki Motor Gujarat Private Ltd instead of Maruti. This subsidiary would be 100 per cent owned by Suzuki while Maruti is only 56 per cent owned by the Japanese parent. Maruti has made a compelling case as to why this proposal should be approved and why it is in its best interests as well as those of the shareholders.

While many investors and analysts have been convinced, there are still a few others, and particularly the proxy advisory firm Institutional Investors Advisory Services (IiAS), who felt that Maruti investors would be short-changed by the proposed structuring of fresh investment and business by Suzuki. The firm has advised shareholders to vote against the proposal, and it may be fighting a lonely battle. The difference in opinion led to a war of words between Maruti and IiAS a few days ago, with Maruti charging the proxy firm of not understanding the business of automobile manufacturing and marketing in its rebuttal to IiAS’ advisory to shareholders.

The proposal

Suzuki Motor Gujarat is to set up the greenfield manufacturing plant in Mehsana, Gujarat with investment of Rs 18,500 crore to manufacture 1.5 million cars and multi-utility vehicles a year for the domestic market and exports. Of this investment, about Rs 8,000-10,000 crore would be in form of foreign direct investment (FDI), according to a Maruti statement on November 24. The capacity of the Gujarat plant will be similar to the combined capacity of the two Maruti plants in Gurgaon and Manesar. It is further proposed that the vehicles manufactured at the Mehsana plant would be sold solely to Maruti to market. Thus, the deal involves Maruti entering into a contract manufacturing agreement with the new subsidiary of Suzuki, where the transaction between the two subsidiaries would be on no-profit, no-loss basis and manufacturing volumes would be set by Maruti.

Need for a new manufacturing subsidiary

Ideally, shareholders of Maruti would have liked this new facility to be invested in and owned by their company rather than by the Japanese parent. When 700 acres of land was acquired in Mehsana in 2012, it was understood that Maruti would be setting up its third plant there. However, in January 2014, it was announced that the parent would be investing in the new plant, using a new wholly-owned subsidiary. It may be remembered that the Mehsana land was acquired at a time Maruti was facing labour problems at its newly commissioned Manesar plant.

India is the largest and the most important market for Suzuki, bigger than Japan. Maruti contributes about 45 per cent of Suzuki’s sales volumes. India is also one of the fastest growing market for automobiles, though much smaller than China. So, the Japanese company sees a lot of potential in India. It can also use that plant as a base to manufacture for other markets including Africa and Europe.

More importantly, Suzuki has large reserves of idle cash that it needs to invest somewhere to earn some returns. It earns almost no returns in Japan and there is no better place to invest than in India, a market it has already understood and has managed to remain a dominant player despite increased competition from Japanese, Korean, European and American automobile makers. One could also say some of the cash that Suzuki took as royalty from Maruti is now coming back to the country.

Proxy firm IiAS reckons the Suzuki move to invest directly comes from its desire to exercise greater control over Maruti as well as the Indian market as well as to capture a greater portion of Indian business valuation in its share price.

Maruti to focus on customers

Shareholders have been told that the contract manufacturing arrangement will immensely benefit Maruti because it can focus on expanding the sales and service network - essential to grow its customer base as well as keep existing customers satisfied. The number of sales outlets are to be increased to match production increase from the Gujarat plant. Likewise, dealer workshops to provide after-sales service is to be trebled from the current 1,700 to 5,000.

Maruti would also gain from treasury income - the money that would have otherwise been invested in the Gujarat plant can be invested in various financial instruments to earn income, which in accounting parlance is also known as "other income". That can help Maruti’s profits look healthier in a slow growth year. But IiAS fears that surplus cash may push Maruti to look at various unrelated avenues to invest, taking focus away from the core business. According to the proxy firm, the company has enough investible surplus to put into the Mehsana plant.

What is not stated by Maruti is that the Gujarat plant can also help offset production loss if there were to be labour unrest at Gurgaon or Manesar. And perhaps also help prevent another unrest at its existing plants. The Manesar strike had cost the company dear in 2012-13.

Big concern areas

The contract manufacturing agreement will have a life of 15 years, and in its present form, is beneficial for Maruti. But, there is always a fear that the agreement can be reset by two parties, and that need not be beneficial for minority shareholders. The company’s share is among the best performers in its peer group currently.

The bigger fear is that Suzuki may decide at some stage that all manufacturing activities be consolidated under its wholly-owned subsidiary - Suzuki Motor Gujarat Private Ltd. That would result in Maruti becoming a sales and services company, leading to possible erosion of value of shareholders’ investment. Shareholders may also perceive such move as a breach of faith they had placed in Maruti’s management.

The result of the voting would be known on December 17, and whichever way the decision goes, there would be ramifications for shareholders of foreign-owned Indian companies.