Maruti’s clarification on Suzuki deal worsens matters
Suzuki Motor Corporation’s (SMC) announcement in January that the new facility for cars would be housed in its wholly-owned Indian subsidiary—Suzuki Gujarat—which would then sell the vehicles to Maruti Suzuki India Limited (MSIL) at cost plus the incremental future capex needs came as a shock to the Street. MSIL, analysts have rightly argued, is sitting on R7,000 crore of cash reserves. So, why shouldn’t it be allowed to produce the cars rather than just market them? Moreover, they have pointed out the depreciation benefits would have helped lower the effective tax rate for the listed entity. The big concern, however, which prompted a clutch of investors to write to the company, relates to transfer pricing issues between MSIL and Suzuki Gujarat. Last week’s clarifications from MSIL, however, haven’t really cleared the air which is probably why the stock lost more than 5% on Friday.
To help fund a part of the Gujarat subsidiary’s capex, SMC wants cars to be sold to MSIL at cost plus a net surplus formula—the sum of this, it says, would be smaller than the price that MSIL gets from its dealers. What’s irking analysts is that there’s still no clarity on the extent of this net surplus because that is what will determine MSIL’s margins—the higher the mark up at the Suzuki Gujarat end, the smaller the operational profit for MSIL. The fear may not be unfounded since wages at the new unit could be higher, pushing up the cost of production. This coupled with the fact that MSIL may not be able to deploy its cash effectively—large, free cash flows from FY16 onwards will push up cash balances further—could hurt returns. Indeed, while the apprehension may appear exaggerated now, the Street is veering around to the view that ultimately MSIL will end up as a marketing company. There is clearly no merit in the proposed arrangement given the plant will be located in India, the engine plant is housed in MSIL which will also be responsible for sourcing components from vendors.
Also, Suzuki has clarified that after 15 years if the terms are not agreed upon by both entities, Suzuki Gujarat will be merged with MSIL at an appropriate valuation—the earlier release had said Suzuki Gujarat would always remain a subsidiary. While it may seem a long time away, SMC’s changing the terms has prompted the question as to why the Japanese multinational wants the current arrangement. Since the detailed contract between MSIL and Suzuki Gujarat appears to be work-in progress, one hopes the final terms will not disfavour the minority shareholders of MSIL and that SMC will do them the courtesy of running the agreement past them even if technically the laws aren’t in place.